PANAMA ECONOMY INSIGHT MONITOR

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Friday, February 12, 2010

Panama Government will reduce the income tax to workers, but will increase the tax on sales


In second half of February of 2010, Legislative Assembly will be discussing a second phase of the tax reform. The first phase occurred successfully a few months ago, when achieved a greater contribution from Colon Free Trade Zone and container transshipment ports, among others economic sectors.

Currently, all those who earn US$9,500 and less per year do not pay income tax; they are 80% of the worker population.
According to Government this range would be extended to US$11,000. Workers with incomes between US$11,000 and US$50,000 would pay 15% on the surplus of US$11,000. Those with incomes between US$50,000 and more would pay US$5,850 more 25% on the surplus of US$50,000.

If the reform is such as was announced by the Government then workers will pay only two marginal rates, the first tax rate would be 15%, for those who earn US$11,000 per year but less than US$50,000 and second tax rate would be 25% for all those workers who earn US$50,000 and more per year. This tax reform would reduce the effective rate for all workers that currently pay taxes.

Currently, tax structure is progressive, based on the principle that those who earn most are those who must pay more taxes. This progressive structure would remain with the tax reform, but effective rates would be substantially reduces for all workers. This progressive structure is appropriate in Panama where wages are relatively low and income distribution is very unequal. Professionals, executives and workers with high salaries are those who have the greatest potential of becoming in entrepreneurs because they can save and invest more, but the current tax structure is a brake to the economic growth and wages. This tax reform will improve the situation of workers that pay taxes.

An aspiration of the new Government from electoral campaign was to become current progressive tax structure in a flat tax. A flat tax is a tax structure with a single rate. Theoretically, this single rate should be chosen of manner such that the sum of tax collected is at least equivalent to the sum collected currently. However, the problem is that will appear winners and losers, because for some its current effective rate would be at the top, while for others would be by below.

The complexity of a flat tax in Panama is that 80% of workers do not pay income tax. In other words, only 20% of the workers contribute to income tax. Panama Economy Insight has estimated that a flat tax of 6% on wage would collect the same amount of current tax structure. However, 50% of the collection comes 80% currently do not pay tax. Therefore, it is very complex to become current tax structure in a flat tax. The Government has sent clear signals that do not implement the flat tax and, instead, will reduce substantially marginal tax rates maintaining the progressive structure. This will reduce significantly the burden on 20% worker population that pay taxes and leave them more money available for consumption, savings or investment.

Nevertheless, ITBMS (a tax on sales) will be increased from 5% to 7% to compensate the reduction of income tax. In consequences, those workers that earn US$9,000 per year and do not pay income taxes, with the tax reform should pay an increase of two percent of ITBMS. However, foods, non alcoholic beverages, electricity consumption, water, books and supplies for students do not pay ITBMS and Government has explained that the negative impact on low income household will be not strong. This increase will affect to consumption of cell phone, Internet, restaurants, clothes, shoes and cars purchases among others goods and services.

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