Costa Rica: Restoring fiscal sustainability and setting the basis for a more growth-friendly and inclusive fiscal policy

Consecutive years of primary deficits have led to mounting public debt of almost 50% of GDP, one of the fastest increases in Latin America over the last decade. Government attempts to restore fiscal health have been undermined by a gridlocked Congress. While only minor reforms have been enacted to contain spending, efforts to curb tax evasion and increase the efficiency of the tax administration are commendable. However, increases in tax revenue have been unable to match mandated increases in spending. As a consequence, sovereign debt ratings have declined to below investment level, and the negative outlook on Costa Rica’s debt signals increasing financing costs. Against this backdrop, the risk of a fiscal crisis is increasing, particularly as global financial conditions become less favourable and debt structure has shifted towards increased reliance on floating rates and dollar-denominated bonds. Enacting a three year fiscal consolidation programme of one percentage point of GDP each year, will enable debt to stabilise at current levels by 2032. The current draft bill to strengthen public finances – Ley de Fortalecimiento de las Finanzas Públicas – proposes a comprehensive fiscal reform package, with measures on both the revenue and the spending side, as well as a fiscal rule. It needs to be complemented with additional measures to contain revenue earmarking. In addition, reducing excessive fragmentation of the public sector would allow the Ministry of Finance to regain control of the budget. There is also room to reduce expenditure on remuneration of public sector workers, one of the fastest growing expenditure items and a source of income inequality. The proposed fiscal rule should be strengthened, including introducing a multi-year expenditure framework and a fiscal council. Debt management should be modernised by stepping up communication with markets and reducing the number of benchmark securities. Over time, improving social spending efficiency and quality as well as modifying the tax structure away from social security contributions and enlarging the tax base would allow for a much stronger contribution of fiscal policy to growth and equity.