The Dominican Republic's Taxing Turn

Servicing its debt will take 44% of government revenue by 2015, despite steep new taxes.
If Democrats had done better in the House on Nov. 6, President Obama might not have to negotiate with Republicans to avoid going over the fiscal cliff. Instead he could simply send his tax increases on "the rich" to Congress where they probably would be approved, without debate, in a matter of days. That sounds good to pundits who bemoan gridlock. And when higher taxes from the 2% didn't curb ballooning deficits, the president could ask Congress to target the earnings of even greater numbers of middle-income Americans. Welcome to the Dominican Republic, which has seen nine "reforms" featuring either new taxes or increases since 2000. The new revenues have never been enough to close a growing hole in the fisc. And so this month President Danilo Medina, using his majorities in the House and the Senate, has rammed through steep tax increases on savers, consumers and producers. Mr. Medina has only been in office since August. But his Dominican Liberation Party has held the presidency for 12 of the past 16 years, with former PLD President and party boss Leonel Fernndez at the helm. Mr. Fernndez is a career politician who, judging from his record, believes that the more people the party bosses have working for the state, and depending on it, the more successful his party will be. The Santo-Domingo-basedRegional Center for Enlarge Image Sustainable Economic Strategies (CREES) has written a summary on the new tax package that Dominicans, with their annual per capita income of $5,500, will have to bear. Some of the lowlights in the report include an increase in the 16% value-added tax to 18%, increases in excise taxes on gasoline and diesel fuel, and a new tax on CO2 emissions added to the price of a new car. The center also reports that taxes on alcoholic beverages, tobacco, cable television and owning an automobile will go north. Savers and investors will be hit with new taxes European Pressphoto Agency on dividends and interest. Salary indexation for Sign reads: Leonel = thief inflation on individual earnings will be suspended for three years, which will push lowincome earners into higher tax brackets. To target the informal sector there is also a new minimum annual tax of $300 for any business with monthly purchases of $1,250 or more. How that will be enforced is not clear. Free-trade zones will face higher income taxes on domestic sales. The new taxes are supposed to produce additional annual government revenue of $1.15 billion, though that seems optimistic. CREES expects something on the order of $800 million in the first year and a decline thereafter as Dominicans adjust behavior in response to higher taxes.

In the meantime, the cost of government is soaring. CREES says government debt (excluding central bank debt and the debt of the state-owned commercial bank) increased to $16.6 billion at the end of 2011 from $6.6 billion at the end of 2004. That's a 152% bump over seven years. CREES forecasts that even if the new additional annual revenue reaches $800 million, the cost of servicing that debt will amount to 44% of total government revenue by 2015, well over the 30% maximum required for sustainability. By the end of this year, interest payments by the treasury are forecast to be up 269% in dollar terms from 2004. According to CREES estimates, after the tax increases, interest payments will reach 30% of total revenue by 2016, significantly more than the 15% typically used to measure sustainability. Think the deficits are about "investing" in education, necessary roads or bridges? Not quite. What's draining the treasury is debt service, subsidies to the government-owned electricity distribution companies, unjustified public-works programs, and a bulbous publicsector payroll for those beholden to Mr. Fernndez as their "patrn." Consider these facts: CREES says government spending on personnel in 2011, in dollar terms, was up 262% from 2004. Columnist Mary Anastasia O'Grady on Separately, transfer payments to fund public the prospects of Catalonian entities was up 608% in dollar terms over the independence. Photos: Getty Images same period. Public works spending is up 288%. CREES estimates that while government revenue will be up 167% in dollar terms for the period 2004-2012, spending will have increased 234% over the same period. Perhaps not coincidentally, the Dominican Republic now leads the world in important corruption measures. Out of 144 countries in the World Economic Forum's 2012-2013 Global Competitiveness Index, the DR is 142nd in "diversion of public funds" and at the very bottom144thin "favoritism in decisions by government officials" and in "wastefulness of government spending." Perhaps no single institution captures the bureaucratic bingeing on taxpayer dollars quite like the country's Foreign Service. According to DR journalist Juan Bolvar Daz, writing on Jan. 22 at the website Hoy, the Foreign Service has "660 diplomats and 503 consular-level personnel" around the world, "many of whom are the product of political clientism and nepotism." The DR diplomatic corps dwarfs that of many much larger countries. Mr. Fernandez, who had to step down after two consecutive terms, will be permitted to run again in 2016 and probably will. If so, his populist, political-patronage model is expected to take him to victory. But at some point he will have to pay for it all. With almost 60% of the economy now "underground," he may find that increasingly difficult, even if he does control Congress. Write to O'Grady@wsj.com