Ecuador: Agreements and Reforms to Reactivate the Economy

In the first hundred days of Guillermo Lasso’s presidency, the international community has seen a radical change in Ecuador’s economic policies. Some of the most notable achievements of the new administration are described below.

On Sept. 8, 2021, International Monetary Fund (IMF) staff and the Ecuadorian authorities reached a staff-level agreement on economic policies to conclude the combined second and third reviews of the 27-month Extended Fund Facility (EFF) program. Upon completion of the reviews, Ecuador would have access to nearly $800 million in financing.

In line with its electoral campaign promises, the new government has fully vaccinated over 9 million Ecuadorians (over half of the population) in the first 100 days of the new administration.

President Lasso and his economic team have been scrambling to file legal and tax reforms and present the 2021 budget to the National Assembly. The reforms are aligned with the president’s goal of complying with fiscal consolidation and envisaged to include both revenue and expenditure measures.

Proposed 2021 Government Budget

On Aug. 22, 2021, the government submitted its proposed 2021 budget to the National Assembly. In a year like this, with a change of administration, the budget is, in reality, a tool that summarizes what has already happened and how the government plans to end the current fiscal year. The new government by law has had to present its budget more than six months into the current fiscal year.

Despite the above, it is important to look at the main figures in the budget. The following are several macroeconomic assumptions in the government’s budget:

• average price of barrel of crude for export: $59.80;
• oil production: 177.26 million barrels;
• GDP: 3.02%;
• nominal GDP: $103.88 billion;
• average inflation rate: -0.05%.

The total income of the proposed budget is $23.04 billion, while total expenses amount to $27.86 billion, resulting in an overall deficit of $4.81 billion, equivalent to 4.63% of the country’s projected GDP.

To comply with the IMF guidelines, Ecuadorian authorities amended the Organic Code of Public Finance Planning (COPLAFIP). Long-term fiscal sustainability will be anchored to the debt ceiling of 57% of GDP by the end of 2025. Despite the latter, and due to the sharp decrease in GDP as a result of the Covid-19 pandemic, it is estimated that debt will reach 64.6% of GDP by the end of 2021.

The proposed budget estimates that approximately 55% of the country’s total income will come from tax collection.

Future Tax Reforms

As part of the initial agreement with the IMF (made in September 2020), Ecuador had committed to increase tax revenues by $2 billion by 2022, through tax reform. In order to create a 1.38 yield(in percentage of GDP) by 2025, Ecuador would have to implement new value-added tax (VAT) collection measures including:

• a 3 percentage-point increase in the VAT rate (from the current 12% rate);
• a reduction in VAT exemptions for universities; and
• the elimination of a VAT refund for the elderly.

The rest of the revenue increase would have had to be achieved by modifying tax norms on personal income tax as well as corporate income tax, among other measures.

In line with the new administration policies, Finance Minister Simón Cueva has announced that the government has been working on a new tax reform that will not increase VAT and announced that there will be a new tax for “the 4% of the population that has a favorable situation and could bear the impact of the coronavirus pandemic.”

The bill was presented to the National Assembly on Sept. 24, 2021 and will be analyzed by a polarized National Assembly, where the Executive Power does not have a majority. We will expand on the proposed bill in a future article.

Capital Outflow Tax and Tax Collection

In the early days of the new administration, President Lasso announced the progressive elimination of the 5% capital outflow tax (ISD) over four years. The first reform on the matter was enacted via an executive decree that established a 0% ISD rate on transfers made by foreign airlines duly authorized to operate in the country.

There is expectation of future reforms of the ISD by industry; however, there will be plenty of analysis and scrutiny of such reforms, as the state coffers rely heavily on tax collection arising from the ISD. In 2019, ISD collection equaled $1.14 billion, and in 2020 it amounted to $964 million. From January to June 2021, revenue from ISD collections totaled $557 million.

As expected, general tax collection fell in 2020, but it has seen a favorable turn during 2021. According to figures shown by the IRS, the ratio of taxes collected/nominal GDP in 2019 was 12.49%, while the proportion for 2020 was 11.76%. In the first half of 2021, the ratio was at 12.58%.

Laffer Curve vs Ecuadorian Reality

In a theoretical world, the Laffer Curve demonstrates the relationship between tax rates and the amount of tax revenue collected by governments. In the case of Ecuador, various factors are being analyzed by economists and tax specialists to determine the effectiveness of a future tax reform.

As explained by Chilicanga, D. & Oliva N. (2017) in “La Curva de Laffer: ¿existe suficiente evidencia que la confirme?” Nota de reflexión No. 47, published by Centro de Estudios Fiscales. Servicio de Rentas Internas (Cef.sri.gob.ec), the structure of the tax system, the ease of transferring to the informal sector, the level of tax rates, among other factors, are variable circumstances that play a pivotal role in the relationship between tax rates and tax revenues.

Regardless, it is evident that any tax reform must be complemented by adjustments in the structure of the tax authority to reduce bureaucratic norms and processes that do not contribute to its primary goal—effective tax collection. The new administration is already working on implementing actions within the Internal Revenue Service in order to comply with international standards and improve internal processes.

Going Forward

The government has been firm in its decision to combat and prevent corruption; it has entered into a Memorandum of Understanding with the United Nations to take effective and sustainable measures to prevent and combat corruption, as well as to promote efficient, effective and transparent public management. The Global Forum on Transparency and Exchange of Information has officially notified that the IRS has complied with its evaluation, which provides access to automatic exchange of information systems.

President Lasso’s approach seems to be correct. Avoiding a sharp increase in tax rates within a fragile society is a lesson he has clearly heeded from the recent Colombian experience: It does not seem like the right move at this time. Increasing collection by using new technologies and modernizing the tax system will help Ecuador comply with the IMF requirements, and will make the country more attractive for investors.

The government has expressed its desire to issue new government bonds in the international markets by 2022, in which case it must guarantee it can manage the economy and the tax system effectively.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Diego Andrés Almeida is the Administrative Partner and Cesar Molina is a Tax Associate at Almeida Guzmán & Asociados.

The authors may be contacted at: daa@almeidaguzman.com; cmolina@almeidaguzman.com