## 1. Growth and Revenue Performance

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### A. Introduction and overview
- Panama’s tax collection has been historically low, reflecting an overarching strategy to promote an investment-friendly environment with low taxation, extensive tax incentives, and exemptions.
- Low taxation has contributed to chronical fiscal deficits and limited fiscal space for social inclusion policies.
- The chapter assesses main features and weaknesses of the Panamanian tax system and provides international comparisons and reform directions.

### B. Growth and tax revenues
- Macro performance and drivers:
  - Real GDP multiplied fivefold over the last three decades.
  - Factors supporting investment: geographic location, trade openness, world-class ports, airport and logistics, financial system depth, and the doubling of the Canal’s capacity.
  - Real annual output expanded on average by 5.9 percent between 2000 and 2019.
- Revenue composition and key fiscal figures:
  - Tax and non-tax receipts each account for about 10 percent of GDP in central government revenues.
    - Social security contributions (SSC) are about 6.0 percent of GDP.
    - Contributions from the Panama Canal Authority are about 3.5 percent of GDP.
  - Tax revenue was 8.2 percent of GDP in 2019 and fell to 7.6 percent of GDP in 2020.
  - Both top PIT and CIT statutory tax rates are 25 percent.
  - After the GFC, tax buoyancy on average remained below unity; CIT and other direct corporate taxes drove the main automatic-stabilizing fiscal responses while PIT share in GDP did not appear to fluctuate with economic conditions.

### C. International tax comparison and tax-expenditure effects
- Comparatives and productivity:
  - Panama’s tax revenue is 8.2 percent of GDP in 2019 — about half of the Latin America average and about 60 percent of the Central America average.
  - Despite statutory rates broadly comparable to peers, Panama’s VAT rate is one of the lowest globally.
  - Relative to Latin America and OECD countries, Panama’s CIT productivity is low.
- Tax expenditures and transparency:
  - Panama does not publish a comprehensive tax expenditure review every year.
  - Legal provisions to curtail tax expenditures (sunset clauses, periodical ex-ante and ex-post evaluation) are absent.
  - In 2019, CIT tax expenditures represented 68.2 percent of CIT revenue.
  - Staff estimate: if tax expenditures were estimated starting with profits reported in tax returns, they would likely be twice as high.
  - Result: tax expenditures represented about 70 percent of CIT revenue in 2019 and CIT productivity is one of the lowest among LACs.
- VAT/ITBMS metrics:
  - VAT C-efficiency was 0.49 in 2017 (and ITBMS C-efficiency 0.49 in 2019).
  - ITBMS productivity is 0.33 (meaning each percentage point increase in the ITBMS rate raises collections by only 0.33 percent of GDP).
  - Average VAT rate across LAC noted as 15.5 percent.

### D. Consumption taxes — ITBMS (Panama’s VAT) and excises
- ITBMS structure and base features:
  - ITBMS standard rate is 7 percent.
  - Higher ITBMS rates: cigarettes and tobacco products 15 percent; alcoholic beverages 10 percent; lodging services 10 percent; pure ethyl alcohol for biofuels 15 percent.
  - Large group of goods and services is exempt.
  - Nonresident providers of digital services are not subject to ITBMS in B2C transactions.
  - Low value imported goods (LVIGs) with purchase price at or below $100 are exempt.
  - Excess input VAT credits can be carried forward; refunds only to exporters of goods and refunds often delayed—DGI has 180 days to finalize the process and refunds often occur only by tax compensation or certificates.
- Revenue performance and determinants:
  - ITBMS revenue is 2.2 percent of GDP; Central America average ITBMS revenue is 5.9 percent of GDP.
  - Low revenue arises from a combination of a low tax rate, a narrow tax base (high level of exemptions), and high non-compliance.
  - Even if the ITBMS rate were raised to 15.5 percent and applied on the same tax base, ITBMS revenue would reach only 80 percent of the region’s average—indicating exemptions and non-compliance materially reduce revenue potential.
  - DGI estimates revenue loss from ITBMS exemptions at 1.29 percent of GDP.
- Distributional incidence of ITBMS exemptions:
  - People in the fifth quintile of income distribution received 42.6 percent of the total benefit of ITBMS exemptions.
  - People in the first quintile received 7.6 percent of the total benefit.

### E. ITBMS — near-term reform priorities and specific issues
- Near-term priorities for exemption elimination should focus on exemptions that:
  - Benefit predominantly the rich.
  - Cause negative externalities (e.g., some fertilizers and insecticides).
  - Are harmful for health (e.g., soft drinks).
  - Generate cascading effects (e.g., fuel products).
- Specific measures and considerations:
  - Eliminate the half-yearly $1,000 exemption for purchases from the Colon Free Port.
  - Consider delaying elimination of all exemptions or raising rates due to pandemic and inflationary pressures, but eliminate some exemptions in the short run to increase fairness, efficiency, and revenue.
  - For fuel products: tax with excises and VAT rather than exempting from VAT — excise aligns with externalities and VAT avoids cascading effects and encourages formalization.
  - Excises on fuel have not changed since 2000 and have fallen in real terms; fuel priced below efficiency prices—excises should be raised, with possible short postponement while oil price spikes due to the war in Ukraine recede.
  - Strengthen border controls to mitigate smuggling given lower fuel prices in neighboring Colombia.

### F. Taxing digital services and LVIGs; VAT compliance and refunds
- Digital services and LVIGs:
  - Preferred approach for B2C services by non-residents is vendor collection—make the vendor or digital marketplace responsible for collecting and remitting ITBMS.
  - Non-taxation of non-resident suppliers of digital services creates unfair competition and revenue losses.
  - The $100 LVIG exemption can add up across transactions and produce substantial revenue costs.
- VAT compliance and refunds:
  - Non-compliance in Panama is very high (some studies estimate near 40 percent).
    - Comparative non-compliance levels: Uruguay 13.3 percent; Chile 25.0 percent; Poland 11.3 percent; Latvia 8.3 percent.
  - Failure to provide timely refunds undermines exports, VAT functioning, business cash flow, and trust in the system.
  - Policy implication: reduce non-compliance and improve VAT refund timeliness for exporters of goods and services.

### G. Excises — yields, composition, and priorities
- Excise yield trends:
  - Excise yield decreased by 0.2 percent of GDP between 2016 and 2019 (from 1.16 percent of GDP to 0.96 percent).
    - 0.10 percent explained by the reduction of the excise on fuel products.
    - 0.10 percent explained by the reduction of the excise on automobiles.
- Excise composition (2019):
  - Fuel products: 0.29 percent of GDP; 30.6 percent of total excise revenue.
  - Automobiles: 0.21 percent of GDP; 21.8 percent of total.
  - Insurance premiums: 0.13 percent of GDP; 13.5 percent of total.
  - Beer, wine, liquor: 0.10 percent of GDP; 10.1 percent of total.
  - Tobacco products: 0.04 percent of GDP; 3.8 percent of total.
  - Soft drinks: 0.02 percent of GDP; 1.6 percent of total.
  - Cable and telecomm: 0.06 percent of GDP; 6.4 percent of total.
  - Gambling: 0.08 percent of GDP; 7.9 percent of total.
  - Other excises: 0.04 percent of GDP; 4.3 percent of total.
  - Total - 2019: 0.96 percent of GDP; 100.0 percent of total.
- Sector-specific issues and recommendations:
  - Cigarettes: excise revenue 0.04 percent of GDP in 2019 (one fifth of the average in LACs); ad-valorem rate 32.5 percent (recommended 70 percent); study estimated 88 out of every 100 cigarettes consumed are contraband—tackle smuggling before raising rates; prefer specific rates per cigarette/package.
  - Alcoholic beverages: excise revenue 0.10 percent of GDP in 2019 (about one third of LACs average); 80 percent of alcohol excise revenue comes from beer taxed with quantum rates — regular indexation recommended.
  - Telecommunications and insurance: 20 percent of excise revenue comes from these; long-term possibility to reduce or eliminate excise on services with positive externalities (starting with telecommunication).
  - Environmental excises: consider excises on plastic bags and hard-to-dispose-of material for environmental benefits despite low revenue potential.

### H. Taxation of labor income — structure, problems, and reforms
- Structure and current revenues:
  - Labor taxation determined by PIT, SSC, and the education security levy (ESL).
  - PIT revenue is 1.8 percent of GDP in Panama.
  - Labor informality level: 40 percent.
  - Minimum wage: $636.
  - Minimum PIT rate: 15 percent.
  - Twenty-seven percent of ESL collection allocated to a special education fund and the rest to the Ministry of Education.
- Problems and recommended reforms:
  - Having both PIT and ESL is redundant and inefficient — recommendation to unify.
  - Exemptions and deductions are very regressive, benefiting the highest decile.
  - Lump-sum compensation for representation expenses: potential net revenue gain close to 0.03 percent of GDP.
  - Deductions for health care and mortgage interest represent about 20 percent reduction of taxes for those deducting.
  - Recommendation: consider introducing an additional lower PIT rate (for example, 5 percent) once PIT revenue increases from elimination of tax expenditures to reduce cost of formalization.
  - Improve data exchange: DGI and social security administration exchange data semesterly only—move to automatic and real-time exchange; DGI lacks access to monthly individual-level earnings and deductions.

### I. Business taxation — structure, incentives, base erosion, and distortions
- CIT and business levies:
  - Territorial CIT regime at rate 25 percent.
  - Loss carry forwards allowed for 5 years; offset per year restricted to 50 percent of taxable income and 20 percent of losses.
  - Payments to nonresidents subject to final withholding of 12.5 percent (lower under treaties).
  - Companies with taxable gross income exceeding $1.5 million subject to CAIR: CIT base is higher of (i) 4.67 percent of the taxable gross taxable or (ii) net taxable income under general rules.
  - Capital gains taxed at 10 percent, except sale of a new property where progressive rates between 0.4 and 4.5 percent apply.
  - Complementary tax: pre-payment of dividend tax on retained earnings charged at 10 percent; applies to 40 percent of net income.
  - Operation levy: 2 percent tax on equity (between $100 and a maximum of $60,000); fixed fee: $300 per year.
- Incentives, special regimes, and examples:
  - Major exemptions include income from international carrier services, passengers embarking/disembarking Panamanian ports, savings, and agriculture.
  - Important incentives: free trade zones, Panama-Pacific Special Economic Area, call centers, tourism, City of Knowledge — qualifying companies have CIT rate zero with varying sunset clauses.
  - SEM and EMMA: CIT rate reduced to 5 percent (had been zero before 2020) and can be reduced via foreign tax credits to a minimum of 2 percent.
  - Concession example: Cobre Panamá exempt from paying any tax (except royalties) if it has outstanding construction-related debt and granted tax credit equal to development capital expenditures.
- Base erosion and anti-abuse recommendations:
  - Lack of proper anti-abuse rules facilitates CIT base erosion.
  - Recommendation: restrict tax deductibility of interest paid to related companies at 30 percent of EBITBA (as in BEPS Action Plan 4); estimated revenue gain: 0.10 percent of GDP.
  - Recommendation: introduce Controlled Foreign Company (CFC) rules to tax income obtained by foreign companies created in low-tax jurisdictions and controlled by Panamanian companies.
  - Rationale: current combination of low withholding (12.5 percent) and territorial regime allows multinationals to shift income to low-tax affiliates.

### J. CIT productivity, international tax developments, and the Two-Pillar reform
- CIT tax expenditures and productivity:
  - In 2019, CIT tax expenditures represented 68.2 percent of CIT revenue.
  - If tax expenditures were estimated from tax-return profits, staff estimate they would likely be twice as high.
  - Result: CIT productivity is one of the lowest among LACs and tax expenditures are very high.
- Recent international developments and Panama’s responses:
  - Since 2015 Panama reformed some incentive regimes to comply with BEPS minimum standards, improved information exchange on request and automatically under global tax agreements, and strengthened banking supervision and AML investigations.
  - Law No. 254 of November 11, 2021 introduced additional accounting-record requirements for legal entities.
  - Panama increased SEM and EMMA tax rate from zero to 5 percent and improved substance requirements.
  - Panama remained on the EU’s list of non-cooperative jurisdictions largely due to lack of compliance with exchange of information standards (EU review updated on February 24, 2022).
  - Global Forum Peer Review (2019) found Panama partially compliant on Exchange of Information on Request.
- Two-pillar international CIT reform implications:
  - Pillar One: applies to MNCs with turnover ≥ €20 billion; aims to reallocate 25 percent of in-scope profits exceeding 10 percent of sales (Amount A) and simplify arm’s length rules (Amount B).
  - Pillar Two: global minimum tax for MNCs with revenues > €750 million; effective tax rate below 15 percent triggers top-up tax via domestic top-up, IIR/UTPR GloBE rules, and treaty-based STTR (applies to income taxed < 9 percent).
  - Panama could introduce a QDMTT to capture top-up taxes domestically; a QDMTT would ensure revenue is collected in Panama but should be contingent on adoption by Panama’s main investment partners.
  - Global minimum taxes would reduce advantages of Panama’s incentives though impact could be small; there is a strong case to review tax incentives regardless.

### K. Distortive rules, efficiency concerns, and PIT progressivity
- Distortions in business taxation:
  - Tight loss carry forward rules (use within five years; strict one-fifth per year and 50 percent cap) discourage risky investment and startups.
  - Complementary tax and operations levy increase debt bias and raise cost of capital; operations levy cap ($60,000) makes it an effective lumpsum for large firms.
  - Dividend tax crediting restricted to within a year, potentially creating double taxation of returns to equity.
- PIT and progressivity:
  - Low PIT collection reduces progressivity; room to introduce a higher top marginal rate (today 25 percent).
  - Priority: evaluate generous/regressive tax expenditures, reduce labor informality, and improve labor tax administration.

### L. Administration, compliance, tax-expenditure management, and broader fiscal implications
- Three main factors explaining low tax revenue:
  1. Non-compliance.
  2. Low tax rates.
  3. Narrow tax bases (high level of tax exemptions and deductions).
- Panama does not publish comprehensive tax expenditure reviews; recommendation to review all tax expenditures, analyze costs and benefits, and integrate tax incentive laws in the fiscal code or a single tax incentive law to increase transparency.
- Need to improve control to reduce non-compliance, smuggling, and informality; administrative improvements (e.g., timely ITBMS refunds, coordination for labor tax data) are required to realize policy gains.
- Example: ITBMS productivity decreased after the 2011 reform that raised the rate from 5 to 7 percent even while eliminating some exemptions.

### M. Concluding reform direction and policy implications
- Desirable reform direction:
  - Reduce tax incentives after analysis and strengthen anti-abuse provisions.
  - Revenues from an international minimum tax can finance reductions in inefficient taxes (e.g., multiple business taxes and strict loss carry forward rules).
  - VAT can be simplified, refunds improved, and rates ultimately raised.
  - PIT can be raised once compliance and enforcement are strengthened to fund social, educational, and infrastructure spending.
- Distributional policy:
  - Revenue-neutral reform that eliminates ITBMS exemptions and uses additional revenue to support the poor directly (for example, via well-targeted social spending programs) would better improve equity.
  - Introduce or strengthen a well-designed income tax to increase progressivity.
- Administrative and compliance improvements:
  - Improve timeliness and mechanisms for VAT refunds.
  - Extend ITBMS coverage to nonresident digital services in B2C transactions and reconsider LVIG exemptions to broaden the base.
  - Improve real-time data sharing between DGI and social security administration.

### N. Banking sector liquidity and synthetic international reserves (reserve adequacy)
- Rationale and measurement:
  - Liquidity in Panama’s banking system mimics “international reserves” in a typical central bank and can be used as a synthetic measure for Panama’s “international reserves”.
  - Close to 90 percent of statutory liquid assets (maturities up to 186 days) are kept as foreign assets.
  - The existing IMF definition counts net foreign assets of BNP (a subset); measuring banking system liquid assets provides a more appropriate synthetic indicator.
- Levels and ratios:
  - Legal Liquidity Index (LLI) minimum set at 30 percent of qualifying deposits; since 2009 LLI between 50-70 percent; end-2021 LLI stood at 60 percent.
  - Total amount of liquid assets in the banking sector amounted to 51 percent of GDP (end-2021).
  - Synthetic international reserves (banking sector liquid assets with maturities below 186 days) amount to 52 percent of GDP.
  - Net foreign assets of BNP measure 14 percent of GDP.
  - Panama’s synthetic reserves equal 110 percent of the IMF ARA metric if classified under a “fixed” exchange rate regime (the ARA benchmark range considered broadly adequate is 100-150 percent).
  - If measured as BNP net foreign assets, reserves amount to 34 percent of the ARA metric.
- Fiscal liquidity and scenarios:
  - Central Government (CG) deposits: 2020 — US$4.4 billion, 8.2 percent of GDP; 2021 — US$3.0 billion, 4.8 percent of GDP.
  - Deposits of decentralized institutions (including CSS): 2020 — US$5.5 billion, 10.1 percent of GDP; 2021 — US$5.1 billion, 9.1 percent of GDP.
  - FAP: 2020 — US$1.4 billion, 2.6 percent of GDP; 2021 — US$1.4 billion, 2.2 percent of GDP.
  - Total fiscal deposits: 2020 — US$11.3 billion, 20.9 percent of GDP; 2021 — US$10.2 billion, 16.1 percent of GDP.
  - At end-2019, CG deposits covered 2.7 months of expenditure; IMF Guidance Note proposes one month as adequacy threshold for fiscal reserves in dollarized economies.
  - Baseline and stress scenarios indicate deposits would remain at or above the one-month adequacy threshold under modeled assumptions; under a deterministic shock deposits start in 2022 at about half a month above the threshold and recover thereafter.
- Policy implications:
  - In fully dollarized economies reserves are mainly liquidity buffers to support banks, government financing, and repay short-term external debt.
  - Panama’s banking sector liquidity has been high due to legal requirements and conservative practices; fiscal reserve buffers were broadly in line with or higher than most other dollarized economies.
  - Assessing reserve adequacy requires judgment; staff adaptations to the ARA metric can be appropriate for Panama’s circumstances.

*Source: IMF staff report excerpt "1. Growth and Revenue Performance" from the Panama chapter.*

### 1. Growth and Revenue Performance ___________________________________________________ 5

### 1. Growth and Revenue Performance

### A. Introduction and overview
- Panama’s tax collection has been historically low, reflecting an overarching strategy to promote an investment-friendly environment with low taxation, extensive tax incentives, and exemptions.
- Low taxation has contributed to chronical fiscal deficits and limited fiscal space for social inclusion policies.
- The paper assesses main features and weaknesses of the Panamanian tax system and provides international comparisons and reform directions.

### B. Growth and tax revenues
- Panama experienced notably robust macroeconomic performance driven by rapid capital accumulation and significant investment; real GDP multiplied fivefold over the last three decades.
- Factors supporting investment: geographic location, trade openness, world-class ports, airport and logistics, financial system depth, and the doubling of the Canal’s capacity.
- Tax and non-tax receipts each account for about 10 percent of GDP in central government revenues.
  - Social security contributions (SSC) are about 6.0 percent of GDP.
  - Contributions from the Panama Canal Authority are about 3.5 percent of GDP.
- After the Global Financial Crisis (GFC), revenues fell; tax buoyancy has on average remained below unity—tax collection has failed to keep up with growth.
- Automatic-stabilizing role after the GFC operated mainly through corporate taxes:
  - Corporate Income Tax (CIT) and other direct corporate taxes exert the largest impact on overall revenue growth.
  - Personal Income Tax (PIT) share in GDP does not appear to fluctuate with economic conditions.
- Key fiscal figures:
  - Tax revenue was 8.2 percent of GDP in 2019.
  - In 2020 Panamanian tax revenue fell to 7.6 percent of GDP.
  - Both top PIT and CIT statutory tax rates are 25 percent.

### C. International tax comparison and tax-expenditure effects
- Panama’s level of tax revenue is low in regional comparison: 8.2 percent of GDP in 2019, about half of the Latin America average and about 60 percent of the Central America average.
- Despite statutory rates broadly comparable to peers, Panama’s VAT rate is one of the lowest globally.
- Widespread use of tax expenditures narrows the base and undermines tax productivity:
  - Relative to Latin America and OECD countries, Panama’s CIT productivity is low.
  - Panama does not publish a comprehensive tax expenditure review every year.
  - Legal provisions to curtail tax expenditures (sunset clauses, periodical ex-ante and ex-post evaluation) are absent.
- Observed metrics:
  - VAT C-efficiency was 0.49 in 2017 (and ITBMS C-efficiency 0.49 in 2019).
  - ITBMS productivity is 0.33 (meaning each percentage point increase in the ITBMS rate raises collections by only 0.33 percent of GDP).
- Average VAT rate across LAC noted as 15.5 percent.

### D. Consumption taxes — ITBMS (Panama’s VAT) and excises
- Structure and rates:
  - The ITBMS standard rate is 7 percent.
  - Higher ITBMS rates: cigarettes and tobacco products 15 percent; alcoholic beverages 10 percent; lodging services 10 percent; pure ethyl alcohol for biofuels 15 percent.
- Base and refund issues:
  - Large group of goods and services is exempt.
  - Nonresident providers of digital services are not subject to ITBMS in B2C transactions.
  - Low value imported goods (LVIGs) with purchase price at or below $100 are exempt.
  - Excess input VAT credits can be carried forward; refunds only to exporters of goods, and refunds are not made timely—DGI has 180 days to finalize the process and refunds often occur only by tax compensation or certificates.
- Revenue performance and determinants:
  - ITBMS revenue is 2.2 percent of GDP.
  - Central America average ITBMS revenue is 5.9 percent of GDP.
  - Low revenue arises from a combination of a low tax rate, a narrow tax base (high level of exemptions), and high non-compliance.
  - Even if the ITBMS rate were raised to 15.5 percent (LAC average) and applied on the same tax base, ITBMS revenue would reach only 80 percent of the region’s average—indicating exemptions and non-compliance materially reduce revenue potential.
- Estimated revenue losses and distributional effects:
  - DGI estimates revenue loss from ITBMS exemptions at 1.29 percent of GDP.
  - Exemptions cover agricultural products and unprocessed food; agricultural inputs (fertilizers, seeds, insecticides); pharmaceutical and medicinal products; medical and educational services; lease or rental of immovable property (Tax Code Art. 1057-V, Par 8), among others.
  - Distributional incidence: benefits of ITBMS exemptions are skewed to higher-income groups:
    - People in the fifth quintile of income distribution received 42.6 percent of the total benefit of ITBMS exemptions.
    - People in the first (lowest) quintile received 7.6 percent of the total benefit.

### E. Policy analysis and recommendations
- There is ample space to modernize Panama’s tax regime to increase progressivity, transparency, and efficiency through revenue-neutral reforms.
- VAT / ITBMS reforms before raising rates:
  - Reduce tax exemptions and/or improve compliance to increase productivity before increasing the ITBMS rate, given current ITBMS productivity of 0.33.
  - Consider moving to a single ITBMS rate; eliminate higher ITBMS rates on alcoholic beverages and tobacco and rebalance revenue via higher excise rates.
  - Lower ITBMS for hotels to the standard rate while eliminating preferential CIT treatment for the sector.
- Tax expenditures management:
  - Publish comprehensive tax expenditure reviews regularly.
  - Introduce legal provisions to curtail tax expenditures (sunset clauses, periodic ex-ante and ex-post evaluation).
- Distributional policy:
  - Revenue-neutral reform that eliminates ITBMS exemptions and uses additional revenue to support the poor directly (for example, via well-targeted social spending programs) would be better suited to improve equity.
  - Introduce or strengthen a well-designed income tax to increase progressivity.
- Administrative and compliance improvements:
  - Improve timeliness and mechanisms for VAT refunds (reduce cascading effects and delays).
  - Extend ITBMS coverage to nonresident digital services in B2C transactions and reconsider LVIG exemptions to broaden the base.

*Source: IMF staff report excerpt "1. Growth and Revenue Performance" from the Panama chapter.*

### 14.      Reforming the ITBMS is essential for growth and fiscal sustainability. While the

### 14. Reforming the ITBMS is essential for growth and fiscal sustainability

### ITBMS (VAT) — near-term reform priorities and exemptions
- Near-term reforms should focus on exemptions that:
  - Benefit predominantly the rich (Table 4).
  - Cause negative externalities (e.g., some fertilizers and insecticides).
  - Are harmful for health (e.g., on soft drinks).
  - Are very inefficient generating cascading effects (e.g., on fuel products).
- The half-yearly $1,000 exemption for purchases from the Colon Free Port "notably complicates control and should also be eliminated."
- The aftermath of the pandemic and external inflationary pressures may justify delaying the elimination of all exemptions and increasing the rate, but some exemptions could be eliminated in the short run to increase fairness, efficiency, and revenue.

### Taxing fuel products: VAT and excises
- Key observations:
  - "Taxing fuel products with excises while exempting them from VAT is not a good or common practice."
  - From an efficiency and compliance point of view, taxing fuel both with VAT and with excise is a better alternative because:
    - Two instruments allow aligning taxes with different purposes: excise set according to the negative externality and VAT set at the rate that targets the overall revenue objective.
    - Registered taxpayers can recover the VAT on inputs, avoiding cascading effects and exportation of taxes.
    - A unique tax (excise) affects both compliant and non-compliant (informal) sectors equally; the VAT impacts the informal sector and final consumers, thereby encouraging compliance and formalization.
- Practical considerations:
  - Excises on fuel products have been reduced historically; specific fuel excise rates "have not changed since 2000 and hence fallen in real terms."
  - Fuel products in Panama are now priced "well below efficiency prices" and excises should be raised, though a small postponement is justifiable until the recent and significant increase of oil prices due to the war in Ukraine recedes.
  - Because the price of fuel products in Colombia is notably lower, any increase requires strengthening border controls to avoid smuggling.

### Taxation of digital services and LVIGs
- For B2C services provided by non-residents, the preferred approach is vendor collection: make the vendor or the digital marketplace responsible for collecting and remitting ITBMS to the DGI.
  - Rationale: "this approach takes advantage of the huge concentration in this market, which facilitates control."
- Problems identified:
  - Non-taxation of non-resident suppliers of digital services creates unfair competition with domestic producers and foreign suppliers of traditional goods and leads to control problems and revenue losses.
  - The tax exemption of $100 for individual LVIGs "can add up over various transactions, leading to substantial revenue costs."

### VAT compliance and refunds
- Non-compliance:
  - "The level of non-compliance in Panama is very high (some studies estimate near 40 percent)".
  - Comparative non-compliance levels cited: Uruguay 13.3 percent; Chile 25.0 percent; Poland 11.3; Latvia 8.3 percent.
- VAT refund system:
  - "The failure to provide timely refunds in cash undermines exports, the functioning of the VAT, vital business cash flow, and trust in the overall system (discouraging exports and capital investment)."
- Policy implication: reduce non-compliance and improve the VAT refund system to exporters of both goods and services.

### Excises — design, yields, and priorities
- Recent yield trends:
  - Excise yield decreased by 0.2 percent of GDP between 2016 and 2019 (from 1.16 percent of GDP to 0.96 percent).
    - 0.10 percent is explained by the reduction of the excise on fuel products.
    - 0.10 percent is explained by the reduction of the excise on automobiles.
- Composition and shares (2019):
  - Fuel products: 0.29 percent of GDP; 30.6 percent of total excise revenue.
  - Automobiles: 0.21 percent of GDP; 21.8 percent of total.
  - Insurance premiums: 0.13 percent of GDP; 13.5 percent of total.
  - Beer, wine, liquor: 0.10 percent of GDP; 10.1 percent of total.
  - Tobacco products: 0.04 percent of GDP; 3.8 percent of total.
  - Soft drinks: 0.02 percent of GDP; 1.6 percent of total.
  - Other excises: 0.04 percent of GDP; 4.3 percent of total.
  - Cable and telecomm: 0.06 percent of GDP; 6.4 percent of total.
  - Gambling: 0.08 percent of GDP; 7.9 percent of total.
  - Total - 2019: 0.96 percent of GDP; 100.0 percent of total.
- Specific issues and recommendations:
  - Cigarettes:
    - Revenue from the excise on cigarettes reached 0.04 percent of GDP in 2019 (only one fifth of the average in LACs).
    - Ad-valorem rate is 32.5 percent, "far from the recommended 70 percent."
    - High smuggling: a study estimated that 88 out of every 100 cigarettes consumed in Panama are contraband and avoid paying taxes; tackling smuggling is a precondition before increasing rates.
    - Most countries use specific rates per cigarette or package to simplify administration and avoid price sub-valuation problems.
  - Alcoholic beverages:
    - Alcohol excise revenue reached 0.10 percent of GDP in 2019 (about one third of the LACs average).
    - Eighty percent of alcohol excise revenue comes from beer taxed with quantum rates (USD per liter), which should be subject over time to regular indexation to retain value in line with inflation.
  - Telecommunications and insurance:
    - Twenty percent of excise revenue comes from telecommunications and insurance premiums.
    - Long-term suggestion: once revenue has increased, Panama could reduce or eliminate the excise on services with positive externalities (starting with telecommunication).
  - Environmental excises:
    - Panama could impose excises on plastic bags and on hard-to-dispose-of material to achieve the double dividend (reduce use and collect revenue), noting revenue is typically low but policy benefits merit consideration.

### Taxation of labor income — structure, problems, and reforms
- Structure:
  - Labor taxation determined by three programs: personal income tax (PIT), social security contributions (SSC), and the education security levy (ESL).
  - PIT standard rates are progressive; the system is based on territoriality and operates predominantly through withholding at source.
  - Social security has 3 branches: old-age and invalidity, health, and occupational health insurance. Bases are generally harmonized.
  - Twenty-seven percent of ESL collection is allocated in a special education fund while the rest is allocated to the Ministry of Education.
- Key observations:
  - "Having two taxes on income, the PIT, and the ESL, is redundant and inefficient and they should be unified."
  - PIT revenue is 1.8 percent of GDP in Panama.
    - Comparative PIT revenue: Uruguay 3.3. percent of GDP; Mexico 3.5; Brazil 3.7.
    - Low PIT revenue explained by high labor informality and deductions and exemptions.
- Deductions and exemptions:
  - Exemptions and deductions are very regressive, benefiting individuals in the highest decile.
  - Lump-sum compensation for representation expenses should be evaluated; "the potential net revenue gain would be close to 0.03 percent of GDP."
  - Deductions for health care expenditures are the single largest item, followed by mortgage interest deduction (they represent about 20 percent reduction of taxes for those deducting).
- Informality and rates:
  - Labor informality level: 40 percent.
  - Panama is one of the LAC countries where labor informality increased since 2005.
  - Minimum wage: $636 (noted as the highest in LACs).
  - Minimum PIT rate: 15 percent (compared with regional averages: 10.8 percent in Central America Countries; 9.3 in LACs; 1.9 in Mexico; and 4.0 in Chile).
  - Recommendation: consider introducing an additional lower PIT rate (for example, 5 percent) once PIT revenue increases from elimination of tax expenditures to reduce cost of formalization.
- Administration and data sharing:
  - Data exchange between the DGI and the social security administration occurs semesterly only; recommendation to move to automatic and real-time data exchange.
  - DGI lacks access to monthly individual-level earnings, taxes, and deductions on wages by employers, hindering efficient administration and control.

### Business taxation — structure, incentives, and base erosion
- Corporate Income Tax (CIT):
  - Territorial regime at a rate of 25 percent.
  - Loss carry forwards allowed for 5 years; offset per year restricted to 50 percent of taxable income and 20 percent of losses.
  - Payments to nonresidents subject to final withholding of 12.5 percent (lower rates may apply under bilateral tax treaties).
  - Companies with taxable gross income exceeding $1.5 million are subject to an alternative minimum tax (CAIR): CIT base is the higher of (i) 4.67 percent of the taxable gross taxable or (ii) the net taxable income under the general rules of the CIT.
  - Capital gains taxed separately at 10 percent, except on sale of a new property where progressive rates between 0.4 and 4.5 percent apply.
- Other business levies:
  - Complementary tax: pre-payment of dividend tax on retained earnings charged at 10 percent; applies to 40 percent of net income, with credit for dividends actually paid.
  - Operation levy: 2 percent tax on equity (between $100 and a maximum of $60,000); applies at the entity level and can apply multiple times within conglomerates.
  - Fixed fee: $300 per year.
- Incentives and exemptions:
  - Major exemptions include income from international carrier services and from passengers embarking or disembarking Panamanian ports and income from savings and agriculture.
  - Important incentives:
    - Free trade zones (e.g., Colon Free Zone), Panama-Pacific Special Economic Area, call centers, tourism, and City of Knowledge: qualifying companies have CIT rate zero with varying sunset clauses.
    - Multinational regional headquarters (SEM and EMMA): CIT rate reduced to 5 percent (had been zero before 2020) and can be reduced through foreign tax credits to a minimum of 2 percent.
- Base erosion and anti-abuse measures:
  - Lack of proper anti-abuse rules facilitates CIT base erosion.
  - Recommendation: restrict tax deductibility of interest paid to related companies at 30 percent of EBITBA (as in BEPS Action Plan 4); estimated revenue gain: 0.10 percent of GDP.
  - Recommendation: introduce Controlled Foreign Company (CFC) rules to tax income obtained by foreign companies created in low-tax jurisdictions and controlled by Panamanian companies at the Panamanian CIT rate.
  - Rationale: current combination of low withholding (12.5 percent) and territorial regime allows multinationals to shift income to low-tax affiliates (e.g., by providing services or loans from low/no tax jurisdictions).

_Italic: Source: IMF staff summary of chapter content provided in the PDF content unit (1panea2023003 - 14)._

### 34.       As a result, CIT productivity is comparatively low (Figure 2.3), and tax expenditures

### 34.       As a result, CIT productivity is comparatively low (Figure 2.3), and tax expenditures

### CIT productivity and tax expenditures
- In 2019, CIT tax expenditures represented 68.2 percent of CIT revenue (Table 6.2).
- The total revenue forgone could be higher because estimates do not include income from foreign sources and have been estimated applying an estimated effective tax rate to turnover, thereby if profitability in firms benefiting from tax incentives is like that of the rest of the economy.
- Staff estimate: If tax expenditures were instead estimated starting with profits reported in tax returns, they would likely be twice as high according to staff estimates.
- Resulting condition: CIT productivity is one of the lowest among LACs and tax expenditures very high (in 2019, they represented about 70 percent of CIT revenue).

### Recent and ongoing international tax developments affecting Panama
- Panama reformed some incentive regimes since 2015 to comply with OECD’s BEPS minimum standards and other international standards, including exchanging taxpayer information on request and automatically under global tax agreements, improved banking supervision, and money-laundering investigations.
- Law No. 254 of November 11, 2021 introduced additional accounting-record requirements for legal entities.
- Panama increased the tax rate on SEM and EMMA regimes from zero to 5 percent and improved substance requirements to comply with BEPS action 5.
- EU listing and peer review status:
  - Panama remains on the EU’s list of non-cooperative jurisdictions largely due to lack of compliance with exchange of information standards; the EU continued to include Panama on the list in the review updated on February 24, 2022.
  - The Global Forum Peer Review Report on the Exchange of Information on Request for Panama (2019, second-round review) found Panama to be partially compliant; conclusions were based, among other things, on gaps in availability of beneficial ownership information.

### Two-pillar international CIT reform and implications for Panama
- Pillar One:
  - Applies to MNCs with turnover of at least €20 billion.
  - Aims at reallocating 25 percent of in-scope profits exceeding 10 percent of sales to market jurisdictions where goods or services are consumed (Amount A) and simplifying the arm’s length principle applied to marketing and distribution activities (Amount B).
- Pillar Two:
  - Introduces a global minimum tax on MNCs with revenues exceeding €750 million.
  - In-scope entities with effective tax rate below 15 percent will be subject to a top-up tax implemented through three mechanisms:
    1. A domestic top-up tax.
    2. Two sets of rules implemented in national tax laws consistently across borders (the Income Inclusion Rule (IIR) and the Under-Taxed Payments Rule), together known as the Global anti-Base Erosion (GloBE) rules.
    3. A tax treaty-based rule (the Subject to Tax Rule, STTR) — the STTR applies only to income taxed less than 9 percent.
  - The IIR allows countries hosting corporate headquarters to impose additional tax on incomes taxed effectively below 15 percent in a source jurisdiction.
  - Panama could capture these taxes by introducing a qualified domestic minimum top up tax (QDMTT), a domestic tax based on the same rules as the GloBE rules.
  - A QDMTT would not change investment incentives of MNCs already subject to global minimum taxes, but would ensure revenue is collected in Panama.
- Interaction with Panama’s incentives:
  - Global minimum taxes would reduce the advantages of incentives offered by Panama, although the impact could be small because the minimum tax affects other capital importers as well.
  - If global minimum taxes fail or are delayed, tax competition pressures remain and a QDMTT might put Panama at a disadvantage; a QDMTT should be contingent on adoption by Panama’s main investment partners (chief among them the United States).
  - Even with adoption of a QDMTT, there is a strong case for reviewing tax incentives.

### Special regimes, exemptions, and domestic tax structure issues
- Panama maintains heavy reliance on special regimes, extensive incentives, and tax holidays; recommendation is to move to more reliance on the general CIT regime.
- Free ports and zones: zones that serve as free ports create few problems, but most zones include exemptions from corporate taxes and income tax for certain expatriates; generosity and number lead to lost revenue and leakage into the domestic economy (physical goods and profit shifting).
- Example: The concession for Cobre Panamá grants the operating company very generous tax holiday:
  - The company is (i) exempt from paying any tax (except for royalties) if it has outstanding debt relating to the construction and development of the project and (ii) granted a tax credit equal to development capital expenditures.
- Tourism sector receives significant tax incentives while facing an increased VAT rate.
- Tax stabilization agreements: may interfere with introduction of domestic minimum tax; new stabilization agreements should explicitly allow imposition of this minimum tax.

### Distortive rules and efficiency concerns in business taxation
- Tight restrictions on loss carry forward:
  - Limitation of use to five years.
  - Strict rules requiring use of exactly one fifth of losses each year and reducing taxable profits by no more than 50 percent per year — likely to discourage risky investment, startups, and innovative firms.
- Complementary Tax and Operations Levy:
  - Complementary tax and the operations levy increase the debt bias and raise the cost of capital for firms marginally financed from equity.
  - Dividend tax crediting is restricted to take place within a year, potentially creating double taxation of returns to equity.
  - Operations levy is a tax on equity; for large enterprises it is effectively a lumpsum tax given an upper limit ($60,000).
- ITBMS (VAT) and excises:
  - ITBMS tax base undermined by tax exemptions and non-compliance and presents several distortions that could be removed to increase efficiency.
  - Excise taxes could be strengthened and aligned more closely to externalities (especially cigarettes and fuel).
  - Cigarettes collect only one fifth of the average in LACs.
  - Fuel excise is very low and has fallen in real terms over time.
  - Opportunity to impose excises on plastic bags and hard-to-dispose-of material on environmental grounds despite low revenue potential.
- PIT and progressivity:
  - Low PIT collection reduces progressivity and limits redistributive effect.
  - There is room to introduce a higher top marginal rate (today it is 25 percent), but priority should be evaluation of generous and regressive tax expenditures and a comprehensive program to reduce labor informality and improve administration of labor taxes.
  - Exemptions and deductions from the PIT base reduce revenues and are very regressive as they benefit individuals in the highest decile of income distribution.

### Administration, compliance, and broader fiscal implications
- Panama’s tax collection has been historically low and shrinking over time, leading to chronic fiscal deficits and lack of resources for human capital and social inclusion policies.
- Three factors explaining low tax revenue:
  1. Non-compliance.
  2. Low tax rates.
  3. Narrow tax bases (high level of tax exemptions and deductions).
- Panama does not carry out and publish comprehensive tax expenditure reviews; recommendation to review all tax expenditures, analyze costs and benefits, and integrate tax incentive laws in the fiscal code or combine them in a single tax incentive law to increase transparency.
- Need to improve control to reduce non-compliance, smuggling, and informality; administrative improvements are required to realize policy gains (e.g., ITBMS refunds delays and lack of coordination between organisms in charge of labor taxes).
- Example: Productivity of the ITBMS decreased after 2011 reform that increased the rate from 5 to 7 percent, even while the same reform eliminated some exemptions.

### Concluding reform direction and policy implications
- Desirable reform direction:
  - Reduction in tax incentives after analysis and stronger anti-abuse provisions.
  - Revenues from an international minimum tax can finance reductions in inefficient parts of the tax system (e.g., multiple business taxes and strict loss carry forward rules).
  - VAT can be simplified, refunds improved, and rates ultimately raised.
  - PIT can be raised once compliance and enforcement are stronger; these measures can fund highly-needed social, educational, and infrastructure spending.

*Source: 1panea2023003 - 34. As a result, CIT productivity is comparatively low (Figure 2.3), and tax expenditures (IMF).*

### 3.      In the last three decades, a construction boom led to a period of unprecedented

### 1panea2023003 - 3.      In the last three decades, a construction boom led to a period of unprecedented

### Historical context and construction boom
- In 1996, the administration of President Balladares embarked on an economic liberalization program, passing a number of reforms that stimulated activity in most sectors.
- In December 1999, the Canal, along with all American military bases, was passed to the Panamanian government.
- Between 2007 and 2016 the Canal underwent a major expansion project, doubling the Canal’s capacity.
- The 2000s witnessed an unparalleled construction boom, with large-scale public investment projects coupled with privately funded residential and commercial property development.
- The majority of Panama City’s skyscrapers were built between 2005 and 2014.
- Cobre Panama and the Canal expansion represented the largest investment projects in the country’s history.
- Real annual output expanded on average by 5.9 percent between 2000 and 2019.

### Major construction and infrastructure projects (selected)
- Tocumen Airport Expansion
  - Renovation and expansion (new gates, boarding bridges and VIP lounge): 2006
  - Northern Terminal (12 new gates, road and taxiways): 2009-12
  - New terminal (20 gates, parking, river diversion and roads): 2012-19
- Panama Canal Expansion: 2007-16 (Expanding existing channels, adding two sets of locks, and raising operating level of Lake Gatun)
- Cobre Panama copper mine (Under the ownership of First Quantum): 2013-19
- Panama City metro Line 1: 2011-14; Line 2: 2015-19; Line 3: 2021 onwards
- Cinta Costera Phases I, II and III (with Maracana Stadium and viaduct): 2009-14
- Tallest Skyscrapers: multiple projects with construction dates spanning 1996–2017 (detailed list provided in source).

### Income convergence and distribution
- Since 1970, Panama’s GDP per capita increased from 22 percent of US GDP to near 50 percent currently.
- Panama is classified as an emerging market, upper-middle income economy.
- Per capita GDP adjusted for purchasing power parity (PPP) stood at US$29,879 in 2019 (30th highest in the Penn World Table sample of 114 countries).
- Using a more complete set of 192 countries from the October 2022 IMF World Economic Outlook, Panama ranks 53rd.
- Convergence path details:
  - Panama’s relative (to the US) GDP per capita declined from 1970 (21 percent) to 1989 (16.5 percent).
  - Panama’s relative GDP per capita improved to around 20 percent in 2000.
  - Post-2000, Panama’s rate of convergence increased rapidly, peaking at 49 percent in 2017 (48 percent in 2019).
  - Amid the pandemic, Panama’s relative GDP per capita ratio slipped to about 48 percent this year, but is expected to recover in the near term.
- Regional and within-country distribution:
  - Over half of the population and most nonagricultural economic activity historically located along the axis between Colon and Panama City.
  - Rural areas remain underdeveloped and rural poverty remains high and particularly elevated and persistent in the comarcas (territories inhabited by indigenous peoples).
- In 2021, Panama’s per capita income adjusted for PPP was US$29,131, outpacing Uruguay (US$22,058) and Chile (US$24,312), and above Costa Rica (US$20,537) and the Dominican Republic (US$19,646).

### Regional perspective and cross-country context
- In 1970, Panama’s per capita output was roughly equal to the aggregate Latin America and the Caribbean (LAC) region and below the level of Chile, Costa Rica, Uruguay, Mexico, Ecuador, Jamaica, Nicaragua, and Barbados.
- Since 1990 Panama’s growth performance has been very strong and, by 2019, Panama had higher per capita output than any other LAC country.
- Among advanced economies, Panama’s closest comparators are Greece and Latvia.

### Growth decomposition — expenditure and industry contributions
- By expenditure:
  - The share of household consumption in GDP declined from 75 percent in 1970 to around 55 percent in the mid-1990s; it increased to 65 percent over the following decade; since the mid-2000s it declined steadily to around 50 percent amid a boom in investment.
  - Demand-side growth accounting shows that the direct contribution to output growth from investment was at its peak in the 2007-19 period.
  - The rapid scaleup in investment was the most important growth driver during 2000-19.
  - Despite output per capita being half of the United States’, consumption per capita is only one third of that of the United States.
- By industry:
  - Construction share in Gross Value Added (GVA) increased from an average of about 5 percent in the 1990s to 20 percent in the second half of the 2010s.
  - Gross fixed capital formation increased from 25 percent to 45 percent of GDP during the same time period.
  - At the peak, about 39 percent of investment was going to construction.
  - Manufacturing share in GVA declined from 20 percent in 1970; to 15 percent in the mid-1990s; to 5 percent by 2020.
  - Transport, storage, and communications increased from 5 percent in 1970 to 10 percent in the mid-1990s and 15 percent in 2020.
  - Agriculture’s share has declined since 1970; labor in Panama is four to five times less productive in agriculture than in construction.
  - Wholesale mining and utilities increased from essentially zero to 7 percent of GVA, reflecting the opening of a very large copper mine.

### Growth decomposition — inputs and TFP
- A growth accounting exercise finds TFP in Panama has been slightly negative since 1990:
  - TFP growth was positive (but small) in the 1990s and 2000s and very negative in the 2010s.
  - TFP declined by 20 percent in the 2010s, nearly double the amount of TFP growth of the previous 40 years.
- Key drivers and interpretations:
  - Growth acceleration driven primarily by residential and commercial construction, Cobre Panama, and public investment projects like the Panama Canal expansion and Tocumen Airport expansion.
  - Such investments take time to reach full utilization (for example, the new copper mine was operating at below 50 percent maximum output in 2019; in 2022 it operated at an output level close to its maximum and doubled its contribution to GVA since 2019).
  - Neoclassical growth accounting mechanically attributes underutilization of capital to TFP, implying that if underutilization is the main cause, a rapid reversal of negative TFP should be expected as capital becomes fully utilized.
  - To explain a decline in TFP of 20 percent since 2009 given a capital income share of 2/3, it must be that around 40 percent of the increase in the capital stock was not yielding output as of 2019, which seems implausible, suggesting other factors also contribute.
- Alternative explanations for declining TFP include:
  - Declining returns to scale or misallocation, in which case the decline should not be expected to reverse.
  - Investment exhibiting smaller spillover externalities to the rest of the economy (no knowledge spillovers).
  - Construction investment could be misallocated due to distortions affecting firm incentives to expand or contract.
  - Construction may yield output not measured in GDP (e.g., use of real estate as a store of value), meaning measured TFP understates actual output.

*Source: Excerpt from the provided IMF content unit.*

### 19.      Compared to other Asian Tigers, or even the fast-growing regional peer Dominican

### 19. Compared to other Asian Tigers, or even the fast-growing regional peer Dominican Republic, Panama has had significantly lower growth in TFP

### Convergence and TFP comparisons
- Singapore demonstrates convergence to the United States without any growth in TFP.
- Taiwan and South Korea converged faster than Panama largely due to faster TFP growth and larger contributions from human capital per worker.
- The Dominican Republic converged slightly faster than Panama (though from a lower base in 1970), largely due to faster TFP growth.
- Counterfactual outcomes since 1970:
  - If Panama had had the TFP growth of Korea or Taiwan (2 percentage points per year), its output per capita would be nearly three times what it is today, above the level of Singapore.
  - If Panama had had the TFP growth of the Dominican Republic since 1970, its output per capita would be 60 percent higher than it is today, around 75 percent of the United States.
- Comparator note: South Korea, Taiwan, and the Dominican Republic have more similar land area to Panama than Singapore (Panama’s land area is 29,157 square miles; Dominican Republic 18,704; South Korea 38,691; Taiwan 13,976; Singapore 281), and Singapore’s much smaller size may imply more severe decreasing returns to scale and hence lower TFP growth.
- Caveat: Panama’s growth is concentrated in Panama City.

### Drivers of lower GDP per capita growth vs. Singapore
- Lower GDP per capita growth relative to Singapore is mostly due to lower contributions from human capital:
  - Employment per capita and human capital per worker contribute less to Panama’s GDP per capita growth than in Singapore.
- Panama has experienced extraordinary growth in physical capital stock per worker:
  - Much of the increase in output per capita is driven by physical capital accumulation and relatively high returns to physical capital.
- Human capital contributions:
  - Human capital has grown substantially in Panama but contributed significantly less to output per capita growth than in Singapore, accounting for 40 percent of the gap in output per capita growth since 1970.
  - The quality of Panama’s labor force increased less since 1970, making up 35 percent of the gap in output per capita growth.
- Education quality and labor market constraints:
  - Panama’s labor force receives a relatively high and growing number of years of schooling (compared to regional peers), but the quality of schooling appears low, with a very small fraction of students achieving the highest levels of performance in internationally standardized math and science exams.
  - Many highly technical professions are barred to foreigners (with listed professions including history, geography, civism; nursing; barbering and cosmetology; odontology; architecture; agricultural sciences; pharmacy; civil engineering; chemical engineering; chiropractic; nutrition; medicine; psychology; medical assistantship; accountability; journalism; laboratory technicians; public relations; speech therapists; medical radiology; economics; social work; veterinary medicine; physical therapy; law; dental assistance; sociology; and chemistry), although loopholes mitigate some negative impacts.

### Policy implications and recommendations
- Need to further develop human capital and total factor productivity (TFP).
- Medium- to long-term priorities:
  - Improve the quality of education.
- Near- to medium-term actions:
  - Facilitate the flow of highly educated foreign workers to encourage knowledge spillovers.
  - Encourage female labor force participation to supply human capital for high-value-added industries and induce knowledge spillovers.

### Box 1 — Neoclassical growth accounting (methodology highlights)
- Aggregate production function assumed (Cobb-Douglas):
  - Yt = At Kt^α Ht^(1−α)
  - At = total factor productivity (TFP); Kt = physical capital; Ht = effective hours of human capital; α ∈(0,1).
- Per-capita decomposition (logs and variables defined):
  - Define ht = log(Ht/MtLt), κt = log(Kt/Lt), ℓt = log(Lt/Nt), lower case variables are logs of others.
  - yt − nt = at + ℓt + ακt + (1−α)ht + (1−α)mt
  - Changes: Δyt − Δnt = Δat + Δℓt + αΔκt + (1−α)Δht + (1−α)Δmt
- Empirical implementation uses Penn World Table decomposition allowing time-varying capital share α (estimated from changing labor share of GDP). Growth of log TFP estimated by:
  - Δat = Δyt − Δnt − Δℓt − ᾱt Δκt − (1−ᾱt) Δht − (1−ᾱt) Δmt
  - Where ᾱt = (αt + αt−1)/2.
- Note: This approach is more general than the simple Cobb-Douglas exact decomposition and does not generally force the exact value of at required to make the Cobb-Douglas function hold.

*Source: IMF staff analysis in the Panama country chapter.*

### References

### 1panea2023003 - References

### Key References Cited
- Bakker, Bas, Manuk Ghazanchyan, Alex Ho and Vibha Nanda, “The Lack of Convergence of Latin-America Compared with CESEE: Is Low Investment to Blame?” (IMF Working Paper 20/98), June 2020.  
- Bakker, Bas, “Have Countries Like Singapore Suffered from Declining Returns to Scale Rather Than Negative TFP Growth?” (Mimeo), November 2022.  
- Beaton, Kimberly and Metodij Hadzi-Vaskov, “Panama’s Growth Prospects: Determinants and Sectoral Perspectives” (IMF Working Paper 17/150), July 2017.  
- Faltermeier, Julia, “Structural Policies in Panama: Background and Policy Recommendations” (IMF Country Report No. 20/125), 2020.  
- Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer, “The Next Generation of the Penn World Table” (American Economic Review, 105(10), 3150-3182), 2015. Available for download at www.ggdc.net/pwt.  
- Hausman, Ricardo, Luis Espinoza, and Miguel Angel Santos, “Shifting Gears: A Growth Diagnostic of Panama” (CID Working Paper No. 325), 2017.  
- Hausman, Ricardo, Miguel Angel Santos, and Juan Obach, “Appraising the Economic Potential of Panama: Policy Recommendations for Sustainable and Inclusive Growth” (CID Faculty Working Paper No. 334), 2017.  
- Maurer, Noel and Carlos Yu, “What Roosevelt Took: The Economic Impact of the Panama Canal, 1903-37.” (Harvard Business School Paper 06-041), 2006.  
- Meditz, Sandra and Dennis Hanratty, “Panama: A country study” (Federal Research Division, Library of Congress), December 1987.  
- Rodrik, Dani, “Premature Deindustrialization” (NBER Working Paper 20935), 2015.  
- Rousset, Marina and Paola Aliperti, “Social Issues in    Panama: Background and Policies”, IMF Country Report No. 20/125, April 2020.

### Measuring Reserves and Assessing Reserves Adequacy — Overview
- Paper objective:
  - Explore challenges and judgements in measuring international reserves in fully dollarized economies according to country circumstances.
  - Derive a “synthetic” measure of international reserves for Panama and assess its adequacy.
- Context:
  - Panama does not have official international reserves; the paper proposes using statutory liquid assets in its banking system as the closest approximation.
- Paper structure (six parts): Section A introduction; Section B experiences of dollarized countries; Section C stylized central bank balance sheet; Section E liquidity buffers in Panama’s banking sector; Section F illustrative measures of Panama’s international reserves using the IMF metric; Section G indicator for government liquidity; Section H policy implications.

### Two Central Questions Addressed
- What are international reserves of a country that does not have its own central bank?
  - For statistical purposes, IMF has defined Panama’s international reserves as the net foreign assets of BNP, after adjusting for IMF transactions.
  - BNP being a commercial bank means its net foreign assets reflect its internal asset diversification policy and may not represent the country’s international reserves.
- What is the appropriate reserve coverage for fully dollarized economies?
  - Dollarized economies do not need reserves to stabilize the exchange rate and do not face currency mismatch risk.
  - “Liquidity buffers” in the adopted foreign currency are needed to support domestic financial institutions, including cross-border deposit withdrawals, and government financing needs.

### Challenges in Measurement and Assessment (Selected Findings)
- Measurement challenges:
  - Panama cannot accumulate reserves by issuing base money in exchange for FX assets (IMF (2013; 2015)).
  - In absence of a central bank, dollars enter the economy via cross-border financial transactions, trade, public borrowing, and investment; any dollar could be used for international trade or cross-border transactions.
  - IMF statistical definition: international reserves = net foreign assets of BNP, but this may not equal country reserves given BNP is a commercial bank.
- Assessment challenges:
  - Quantifying external risks, vulnerabilities, and opportunity costs is complex; assessment should be tailored to country characteristics.
  - Existing IMF ARA metric was developed for fixed and floating regimes; Panama is fully dollarized, requiring judgment and possible workarounds (e.g., compare with fixed regime ARA metrics or with emerging economies’ synthetic-reserve-to-GDP ratios).

### Proposed Approaches and Indicators
- Synthetic international reserve indicator proposed to measure reserves in Panama.
- Cash buffers of the central government (held as deposits at BNP) identified as another important liquidity indicator.
- Suggested comparative approaches:
  - Compare Panama with ARA metrics of countries with fixed exchange rate regimes (treat Panama as “fixed” for this purpose).
  - Compare Panama’s ratio of “synthetic international reserve” to GDP with other emerging economies.

### IMF ARA EM Metric — Description and Parameters
- Purpose: gauge adequacy of international reserves by capturing potential drains on the balance of payments.
- Four components:
  - Export income
  - Broad money
  - Short-term debt
  - Other liabilities
- Relative risk weights derived from the 10th percentile of observed outflows during exchange market pressure episodes, by exchange rate regime.
- Table of weights (In Percent):
  - Fixed: Short-term Debt 30; Other Liabilities 20; Broad Money 10; Export 5; Without CFM 10
  - Floating: Short-term Debt 30; Other Liabilities 15; Broad Money 5; Export 2.5; With CFM 5
- General benchmark: reserves in the range of 100-150 percent of the composite metric are considered broadly adequate for precautionary purposes.
- Note: Other traditional metrics include import coverage, ratio of reserves to short-term debt, and ratio of reserves to broad money.

### Experiences from Other Dollarized/Euroized Economies (Selected Practices)
- Sample: 12 countries use another country’s legal tender; 7 use U.S. dollar (Ecuador, El Salvador, Panama, Republic of Marshall Islands, Federates States of Micronesia, Palau, Timor-Leste); 3 adopted the euro (Kosovo, Montenegro, San Marino); 2 use Australian dollar (Kiribati, Tuvalu).
- Variations in institutional setups:
  - Six countries have a central bank with limited functions; national or development banks often perform some functions; Republic of Marshall Islands has neither monetary authority nor public bank.
- IMF staff adaptations to measure reserves or adequacy:
  - Micronesia, Palau, Republic of Marshall Islands: reserves measured by U.S. dollar deposits by the government in local banks (IMF (2016b; 2018a; 2018c; 2019c)).
  - Timor-Leste: reported “public foreign assets” including Petroleum Fund balance and central bank official reserves.
  - Tuvalu: added foreign assets of the National Bank of Tuvalu, Consolidated Investment Fund, and SDR holdings.
  - San Marino: estimated aggregate liquidity buffers including reserves and decentralized liquidity buffers held by commercial banks outside the central bank.
- Modified adequacy metrics used in practice:
  - Substitute central government deposits for foreign reserves and compare against imports or government spending (Micronesia, Palau, Republic of Marshall Islands).
  - San Marino: alternative metric including 100 percent of demand deposits of banks, reserve requirements, contingent liabilities, two standard deviations of historical central bank financing to government, committed credit lines, and 100 percent of demand deposits from other public institutions; evaluated government deposits as months of government spending.
  - Montenegro: replaced broad money with deposits, raised its weight from 10 percent to 15 percent, and eliminated “other liabilities” component.
  - El Salvador: reserves adequacy = 30 percent of short-term public debt at remaining maturity + 30 percent of deposits + 1 month of Central Government budget − Central Bank’s funds.
  - Ecuador: supplemented standard metrics by an absolute reserve floor covering minimum liquidity buffers including (i) all deposits of the banking system at the central bank; (ii) money issuance and securities issued by the central bank; (iii) electronic money; (iv) measure of volatility of public credit; and (v) contingent liabilities.

### Stylized Central Bank vs. Panama’s Banking System Balance Sheet (Selected Points)
- Typical central bank balance sheet:
  - Liabilities: currency in circulation and reserves of commercial banks (required and excess); government excess cash deposited at central bank; non-monetary liabilities include securities issued by central bank.
  - Assets: foreign currency assets (“international reserves”) and domestic currency assets (mostly government bonds and some deposits).
  - Equity: may be low; reserves often built from retained earnings.
- Panama (no central bank) — banking system balance sheet differences:
  - Asset side: predominately liquidity in the banking system; commercial banks (including BNP) deposit close to 90 percent of their liquid assets abroad (deposits in overseas banks, investment in liquid global bonds and other liquid foreign assets). This is akin to net foreign assets (“international reserves”) in a traditional central bank balance sheet.
  - Liability side: mainly deposits from government and private sector; public sector deposits are mainly central government excess cash deposited at BNP.

### Liquidity Buffers — Composition (Banking System / BNP)
- Liquidity (Excess cash placed as deposits in Banco Nacional de Panama (BNP)):
  - Short-term assets with maturities up to 186 days, comprising:
    - Assets held abroad (84%):
      - Deposits in foreign banks (29%)
      - Investment in foreign liquid assets (24%)
      - Loan service installments up to 186 days (15%)
      - Other liquid assets (16%)
    - Assets held locally (16%):
      - Deposits in Panamanian banks (6%)
      - Legal tender money in Panama (3%)
      - Panamanian T-Bills (1%)
- Sources: Banco Nacional de Panama (BNP), Superintendency of Banks (SBP).

*Source: 1panea2023003 - References (PDF chapter/section).*

### 15.      Given that liquidity in the banking system mimics “international reserves” in a typical

### 15.      Given that liquidity in the banking system mimics “international reserves” in a typical

### Synthetic measure of Panama’s international reserves
- Rationale:
  - Liquidity in Panama’s banking system mimics “international reserves” in a typical central bank and can be used as a synthetic measure for Panama’s “international reserves”.
  - Close to 90 percent of the statutory liquid assets (maturities of up to 186 days) are kept as foreign assets, akin to international reserves (net foreign assets) in a typical central bank’s balance sheet.
  - The IMF Guidance Note on the Assessment of Reserve Adequacy and Related Considerations (2016) supports using liquidity buffers in the adopted foreign currency for fully dollarized economies to support domestic financial institutions and government financing needs.
  - The existing IMF definition of international reserves only accounts for net foreign assets of BNP (a subset of the banking system); using liquid assets in the banking system provides a more appropriate synthetic international reserve indicator.

- Composition note:
  - Remaining liquidity is held in domestic treasury bills, interbank deposits, and cash kept in branches for banking operations.
  - Statutory Legal Liquidity Requirement defines liquid assets as short-term assets with maturities below 186 days and qualifying deposits include deposits with maturity up to 186 days.

### Banking sector liquidity and regulatory framework
- Legal and regulatory metrics:
  - The Superintendency of Banks (SBP) defines the statutory liquidity requirement as the Legal Liquidity Index (LLI), set at a minimum of 30 percent of qualifying deposits.
  - Since 2009, Panama’s LLI had been between 50-70 percent; as of end-2021, the LLI stood at 60 percent.
  - The total amount of liquid assets in the banking sector amounted to 51 percent of GDP (end-2021).

- Basel III and complementary measures:
  - Authorities phased-in Basel III liquidity coverage ratio (LCR) in 2022; as of November 2022 all general licensed banks have met the LCR requirement.
  - Authorities are considering implementing the Net Stable Funding Ratios (NFSR), capital conservation buffer, and surcharge for domestic systemically important banks.

### Reserve adequacy findings and metrics
- Synthetic reserves level:
  - Panama’s synthetic international reserves (measured by banking sector liquidity, short-term liquid assets with maturities below 186 days) amount to 52 percent of GDP.
  - By contrast, net foreign assets of BNP measure 14 percent of GDP.

- Cross-country and metric comparisons:
  - Within a sample of 76 emerging economies, Panama’s synthetic reserves-to-GDP ratio ranks among countries in the third quartile.
  - ARA Metric: If Panama is categorized under a “fixed” exchange rate regime, Panama’s synthetic international reserves are equivalent to 110 percent of the standard IMF’s ARA metric (within the range of 100-150 percent of the metric that is considered broadly adequate).
  - If measured as BNP’s net foreign assets, reserves amount to 34 percent of the standard IMF’s ARA metric.

- Historical coverage and benchmarks:
  - Since 2009, banking sector liquid assets averaged around 60 percent of short-term liabilities (well above the minimum requirement of 30 percent).
  - Fiscal reserves had an average coverage of 2.4 months of central government expenditure from 2009 to 2021 (above the benchmark of one month of central government expenditure for dollarized economies).

### Government liquidity (fiscal reserves) and scenarios
- Current fiscal buffer metrics:
  - Panama’s Central Government (CG) deposits amounted to US$3 billion and 4.8 percent of GDP in 2021.
  - Assets worth US$1.4 billion (2.2 percent of 2021 GDP) are in the balance sheet of the Savings Fund of Panama (FAP), but fiscal legislation limits their utilization for financing government deficits in normal times.
  - Table summary (selected metrics, as presented):
    - CG deposits: 2020 — US$4.4 billion, 8.2 percent of GDP; 2021 — US$3.0 billion, 4.8 percent of GDP.
    - Deposits of decentralized institutions (including CSS): 2020 — US$5.5 billion, 10.1 percent of GDP; 2021 — US$5.1 billion, 9.1 percent of GDP.
    - FAP: 2020 — US$1.4 billion, 2.6 percent of GDP; 2021 — US$1.4 billion, 2.2 percent of GDP.
    - Total: 2020 — US$11.3 billion, 20.9 percent of GDP; 2021 — US$10.2 billion, 16.1 percent of GDP.

- Adequacy thresholds and stress scenarios:
  - IMF Guidance Note (2016a) proposes one month of central government spending as an adequacy threshold for fiscal reserves.
  - At end-2019, before the pandemic, CG deposits covered 2.7 months of expenditure.
  - Scenario analyses:
    - Baseline: If US$1 billion of CG deposits is used to pre-finance debt amortizations and deposit withdrawals are limited, the one-month adequacy threshold would continue to be observed over the medium term (per Table 3 assumptions and October 2022 WEO projections).
    - Stochastic risk scenario: 10,000 normalized shocks on CG expenditure/GDP ratio based on historical average and standard deviation; the 95th percentile of the distribution selected per year. Under this scenario, deposits would remain well above the threshold of 1 month of CG expenditures over the whole period.
    - Deterministic risk scenario: Expenditure about 1.75 percent of GDP above baseline at the peak of the shock (i.e., 1.4 standard deviations) and deposits 40 percent lower than baseline due to refinancing constraints. Under this scenario, deposits in months of expenditure start in 2022 at about half a month above the threshold and recover thereafter.

- Alternative fiscal liquidity buffer strategies and public debt implications:
  - Baseline strategy: deposits gradually decline from 3 months in 2021 to 1.8 months in 2027; NFPS debt falls from 58.4 percent of GDP in 2021 to 52.1 percent in 2027.
  - Raise CG expenditure coverage to 4 months until 2027: public debt would reduce only slightly relative to baseline to 55.8 percent of GDP (noted relative to 2021).
  - Fix CG deposits at 3 months: public debt would fall to 52.5 percent of GDP by 2027.
  - Lower deposits to 1.5 months from 2022: public debt would fall to 47.7 percent of GDP in 2027.

### Conclusions and policy implications
- Role of reserves in fully dollarized economies:
  - Fully dollarized (or euroized) economies do not face exchange rate fluctuation risk or currency mismatches; their need for international reserves is largely for foreign exchange liquidity buffers to support domestic financial institutions, government financing, and repay short-term external debt.
  - These liquidity buffers are driven directly by banks' deposits, fiscal balance, and movements in public debt.

- Assessment challenges and staff approach:
  - Assessing reserve adequacy in fully dollarized economies requires judgment due to multiple roles of reserves, complexity in quantifying external risks and vulnerabilities, and opportunity cost considerations.
  - IMF staff have supplemented or modified the definition of international reserves in certain cases to reflect country circumstances, focusing on reserves’ role in providing liquidity to domestic financial institutions and financing government obligations.

- Panama-specific policy implications:
  - For Panama, international reserves can be synthetically approximated by domestic banking system liquidity.
  - Over the last decade, Panama’s banking sector liquidity remained high due to legal requirements and conservative banking practices, and fiscal reserve buffers were broadly in line with or higher than most other dollarized economies.

*Source: IMF staff report excerpt (chapter on liquidity in Panama’s banking sector and reserve adequacy).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1panea2023003.pdf_