Municipal Taxation in San Salvador

Patricia Fuentes and Mario Lungo, May 1, 1999

The demand for urban services surpasses the financial capacity of most cities around the world. To address this problem, many municipal governments successfully use the property tax, combined with other management instruments, to raise needed revenues. In Central America, El Salvador is the only country that does not currently have a tax on land and buildings. However, public officials, academic experts and business leaders have begun to discuss the necessity of establishing a property tax system and strategies for its implementation.

El Salvador’s taxation system is recognized as being inequitable and the amount of tax actually collected is very low, thus affecting the level of public investment. Decades of civil war and economic chaos left the country without an established tradition of fiscal management and controls. Changes in the taxation system began in 1993 when the former patrimonial tax on personal and business property, including real property, and the 5-percent sales tax were both abolished and replaced by a 13-percent sales tax. These taxes, and an ongoing income tax, are all collected by the central government.

The only municipal tax is an archaic and complex tax based on commercial, industrial, financial and services activities. Because of their limited capacity to raise revenues, municipalities have few opportunities to contract loans from national banks and no possibility of obtaining loans from international financial institutions. Administrative deficiencies, cadastral problems and limitations of the legal framework also contribute to the weak financial base of the municipal governments. Since metropolitan San Salvador encompasses such a large part of this small country, local taxation and other fiscal planning programs introduced there have a significant impact on the entire country.

In 1998 the Municipal Council of San Salvador proposed increases in its business activity tax, raising immediate debate among business organizations and municipal officials. Business leaders argued that the proposed tax program would generate additional costs, compelling them to raise the price of goods and services and possibly provoking inflation. They demanded incentives for new development in exchange for any changes in the tax system. The Municipal Council defended its proposal, arguing that the current tax structure was seriously inequitable because it punished smaller enterprises while offering advantages to larger ones.

The Municipal Council of San Salvador and the Trade and Industry Chamber of El Salvador formed a joint commission to investigate the complex issues involved in the proposed tax reform, and the preconditions such as updated cadastres, the legal framework and technical training that would be necessary. While no concrete mechanisms for implementing land and building taxation were incorporated into the discussion, it was significant that these key stakeholders reached consensus on the need for a property tax in the future.

Benefits of an International Perspective

In a precedent-setting meeting of public officials and private stakeholders in January 1999, the Lincoln Institute and the Planning Office of the Metropolitan Area of San Salvador (OPAMSS) examined many issues regarding the development and implementation of a property tax system. This was the third in a series of Institute-sponsored programs designed to share international expertise and to help develop a new framework for a more equitable tax system in El Salvador.

Particularly in a small country like El Salvador, an adequate property tax system can have positive and strategic effects not only on local finances but also on macro-economic policies and on the re-engineering of a country’s financial sector. Alven Lam, a fellow of the Lincoln Institute, explained that restructuring the taxation framework has been essential to allow some Asian countries, such as Japan, Thailand and Indonesia, to recuperate from their economic crises. The recent fiscal problems in Brazil and ongoing debate about the functioning of the financial sector in El Salvador added a sense of urgency to this discussion of the broader economic context of a local property tax.

The seminar also addressed the importance of integrating land and building taxation as a fundamental tool to promote effective urban land management. Vincent Renard of the Econometric Laboratory of the Polytechnic School in Paris commended the initiative taken by the San Salvador Municipal Council and other local governments to modify their taxation structures, but stressed that these policies can not be isolated from an overall understanding of real estate markets. He also criticized urban planning approaches, such as the current tendency in El Salvador, to over-regulate land use through legal measures without any link to land taxation and fiscal incentives.

A third area of concern to the policy debate was the political and economic implications of property taxation. Among other things, it is critical that those involved in establishing a property tax system consider the political culture of the society, the consolidation of municipal autonomy, the transparency of real estate markets, and the use of the property tax as a tool for economic and social development. Julio Piza, from Externado University in Bogota, described different applications of the property tax in Colombia. He highlighted a common problem, the difficulty of measuring the land and building tax bases due in large part to obsolete current cadastres and the lack of other land information systems.

Although discussion of property tax reform in El Salvador has been overshadowed by recent national elections, the new president has expressed interest in land and tax policy. Among the seminar participants were many municipal and national leaders from the political and business sectors who are committed to modernizing their municipal taxation and fiscal management programs. The fact that they met to openly discuss these difficult issues is a hopeful sign. Key factors for future progress include the political will to promote a local property tax, the continued involvement of the business community, and recognition that the tax is both a practical financial instrument to meet immediate needs and an important tool for economic growth and urban development.

A major challenge for El Salvador, as for other countries experiencing social and economic transitions, is establishment of equitable and effective provisions for property valuation and tax collection. Starting with a simple rate structure and gradually introducing more sophisticated instruments can ease the implementation process. Issues such as innovative urban land management and the possibility to capture increments in land value are also critical for the future fiscal growth of El Salvador.

Patricia Fuentes is subdirector of Urban Development Control and Mario Lungo is executive director of the Planning Office of the Metropolitan Area of San Salvador (OPAMSS).

Municipal Revenues

Metropolitan Area of San Salvador, 1993

Sources of revenue:

a) Municipal taxes 41%

b) Tariffs and user fees 36%

c) Transfers from central government 8%

d) Other municipal revenues 5%

e) Loans 4%

f) Other sources 6%

Revenues per capita (US $) $15.59

Capital investment per capita (US $) $1.04

Debt service as a percentage of total expenses 6.55%

Source: Indicadores Urbanos y de Vivienda, Vice Ministerio de Vivienda y Desarrollo Urbano, 1996, San Salvador.