Tax Reform: Trends and Possibilities

Central America’s economic performance improved markedly in the 1990s.1 But there remain many challenges for this region, especially in strengthening the public finances and revenue yields. Achieving and maintaining a sound fiscal position is essential for macroeconomic stability and for creating the appropriate conditions for sustained economic growth. Key issues are to reform the system of taxation to achieve a sound structure that is buoyant in generating revenue, distorts economic decisions as little as possible, and achieves the degree of redistribution that is consistent with equity goals. Because Central American countries are small, open economies, another goal is harmonization of their tax systems with each other to better enable producers to compete with the surrounding, larger neighbors, such as México or Colombia, and to avoid harmful tax competition for scarce resources such as capital and skilled labor. Harmonization can also facilitate tax and customs administration. Harmonization of the domestic tax system is complementary to harmonization of trade regimes, through efforts such as those made by the Central American Common Market.