The debate on how to cover the gigantic fiscal gap that Ecuador has of at least 5.5 billion dollars, a deficit that has been deepened by the need to inject resources into the armed forces and the police, in order to fight against drug crime, is being conducted in the National Assembly amid the rejection of the executive’s proposal to raise the value added tax (VAT) by 3 points from 12% to 15%, but with alternatives that, according to experts and the Minister of Economy and Finance himself, would not be suitable, Juan Carlos Vega Loše.

What are the proposals of the assemblyman?

In this regard, Jaime Carrera, executive secretary of the Observatory for Fiscal Policy (OPF), believes that proposals for the temporary nature of VAT or the introduction of additional taxes on banks are not advisable. Measures that will take time to implement (such as selling companies or abolishing ministries) are also not good options at this time of urgent resource needs.

Regarding VAT, he explains that the fiscal situation is extremely serious and requires an increase in taxes in order to achieve permanent income and follow the path of fiscal sustainability. Any shortcut taken to avoid providing permanent revenue to the treasury will only serve to destabilize public accounts and affect dollarization, he explains.

A three-point increase in VAT would raise $1.3 billion, according to SRI

For Carrera, the VAT increase is the right option, because it provides permanent income to the state and does not affect the poorest, because products related to the basic basket, education, healthcare, do not have VAT. Furthermore, while the middle class will experience growth, it would be affordable. For example: if you buy a device for USD 200, and with VAT it costs USD 224, by increasing it to 15%, that device would increase to USD 230, that is, it would increase in price by USD 6. This, he says, is in exchange for healthy public accounts.

The authorities warn of economic and security consequences if VAT is not increased to 15 percent

In the meantime, Minister Vega Malo clarified before the Economic Development Commission of the Assembly that “if we do not take this measure, we are closed to financing from any foreign entity.” What the country needs most is funds, large funds from abroad, so that we can finance the war against insecurity and face the economic and social problems that the country has.”

Why is it not a good idea to influence banking?

Regarding the intention of the representatives to impose higher contributions on the banks, Carrera assures that a solid financial system is needed for dollarization, so it is not good to influence the banks either. The expert explains that the financial system has problems with reducing liquidity in several ways. Both interest rate policies and the country’s high risk – on January 16 it was 1,930 points – and the thousands of debt restructuring cases they had to do due to the pandemic limit their credit management. He explains that it is not enough to just throw out a figure on the topic of profit, as it relates to capital. And the 12% profit they achieved in 2023 is the lowest in Latin America.

On a related note, the Association of Private Banks of Ecuador (Assobanca) reports that in 2023, private banks recorded a profit of 737.5 million USD with an ROE (return on equity) of 12.3%. This is a profitability that is not so high compared to other sectors.

In the Law on Energy, a ‘provision penalizing the arrival of fresh sources from abroad to Ecuador via banks’ was approved.

The subject explains that banks were previously subject to the self-tax percentage, as it existed from March 2020, but it was set at a fixed percentage of 1.75%, and will now be between 4% and 5%, which would mean that the amount of withholding tax for private banks would increase from $140.26 million to $360 million each year, an increase of $220 million, a figure that is more than double the previous withholding (157% additional).

According to the Internal Revenue Service (SRI), it is proposed to raise an additional $1.3 billion in tax revenue. That is, private banks would contribute approximately 17% for this concept.

This effort, which will affect less liquidity for credit approval, in addition to all the additional taxes currently applied to banks, is essential support for the state at this time.

Subsidies in the spotlight

On the other hand, the former Minister of Finance, Fausto Ortiz, indicates that the VAT in 2023 for 12% meant 6.184 million dollars. He believes that, if it were to be temporary and at 15 percent, extra gasoline should also be increased by 50 cents, and diesel should be gradually focused on.

Gasoline and diesel prices could vary in Ecuador in two ways: the tax law and the revision of subsidies

Tax cuts would reduce country risk, increase investor confidence and provide resources from multilateral societies, he comments.

For his part, Carrera believes that it is time to undertake an economic correction, otherwise we will go from crisis to crisis for another 40 years and warns that something like what happened in 1999 should not be caused.

Regarding the possibility of focusing on fuels, he indicated that an effective increase in VAT would not be enough, explaining that in addition to the deficit of $5,500 million, there are arrears of $4,000 million and depreciation of $5,000 million. The need for financing would reach $14.5 billion this year, which is a colossal figure.