Tax Reform in Panama is Needed to Comply with Fiscal Consolidation According to Fitch

The goal of José Raúl Mulino’s government to reduce the fiscal deficit this year, from the 7.35% reported at the end of 2024, to 3.88% will be a difficult mission.  The fiscal deficit closed at more than $6.4 billion in 2024.  Fitch estimates that the government’s deficit will grow higher, as it faces the challenge of financing the Social Security Fund, given the National Assembly’s refusal to approve the increase in the retirement age, and that Panama will not be able to comply with fiscal consolidation without tax reform.  Fitch also says that it is unclear how the government will reduce spending to reduce the fiscal deficit and warns that CSS reform may not be enough for Panama to maintain its investment grade status. 

The Fitch analysis, presented to bankers, financial analysts, and business leaders in Panama City, suggests that it will be nearly impossible for the government to achieve fiscal consolidation because the government is not expected to achieve its goals, given the current scenario of low tax collection, a large number of tax exemptions, in addition to tax evasion and the financial pressure on state coffers to cover the nearly $1 billion for the Social Security Fund.  Todd Martínez, pictured below, senior director at Fitch Ratings, noted that Panama needs tax reform and that Panama will not be able to comply with fiscal consolidation without tax reform and warns that Panama could face another downgrade in its credit rating from the agency, which already downgraded the country to BB+ or speculative grade in March 2024. 

“We’ve discussed many risks of the fiscal consolidation process, including the revenue component without tax reform and the difficulty of reducing spending. If all of this means the government can’t even meet our fiscal projections, the debt would be on an even steeper trajectory, and that could lead to a downgrade.” he warned.  The sovereign risk analyst explained that the government will not be able to achieve its fiscal target without implementing tax reform, eliminating several exemptions, curbing spending, reviewing subsidies, and effectively improving tax collection, among other measures.  “The government wants a 5.4% consolidation over five years, primarily on the revenue side, and we’re projecting a slightly smaller consolidation, but one that’s much more focused on capital spending.” 

Martínez indicated that a measure to encourage people to request their bills does not generate the additional revenue the country needs to cover the shortfall in revenue to support the entire state structure.  “We see it as very difficult for a country to achieve this without tax reform.  I understand that the government aspires to achieve this through administrative means, by encouraging the population to request their tax receipts, and through other internal efforts. However, in our opinion, such significant growth in revenue will only be feasible through tax reform, which, for now, does not appear to be on the horizon,” he said.  Regarding spending, he indicated that there is no clarity about the cuts the government could make this year and in the future. 

Martínez stated that, although the passage of the Social Security Fund (CSS) reform is a step forward, much of the institution’s financial burden falls on the State, which will have to spend nearly $1 billion to cover the pension deficit.  “The reform of the Social Security Fund will not reduce this operating deficit. There will be higher contributions from employers, but that will perhaps offset the demographic pressure,” said Martínez.  He insisted that the reform as it emerged from the National Assembly leaves the State with greater financial influence over the CSS. “Without raising the retirement age, this reform of the Social Security Fund is like a 90% government bailout of the system and only a 10% adjustment for the private sector through raising the retirement age. The government can focus on other issues, but 90% of the problem is simply shifting to the central government deficit,” said Fitch’s senior director of sovereign debt.