Professor of Economics at the Johns Hopkins University and Forbes columnist, Steve H. Hanke concludes that the incoming Leonel Fernandez administration will need to embrace bold reforms to reverse the present recession and double-digit inflation. Hanke?s proposal is in keeping with the argument being made for less taxes and currency liberalization made by economist Frederic Emam Zade, who has been in strong disagreement with the tax reform proposals made so far by the team of leading PLD economists Rafael Camilo, Juan Hernandez and Daniel Toribio.
In the study ?The Dominican Republic: Resolving the Banking Crisis and Restoring Growth,? Hanke proposes that the centerpiece be a dollar-based monetary reform aimed at producing a hard budget constraint and stable money. In addition, he says the tax system needs to be reformed to improve compliance and enhance the incentives to work, save and invest.
Hanke proposes the country choose one of three dollar-based monetary reform options: a currency board, a dollarized system or a free banking regime to restore confidence. Regarding tax reform, he recommends that the country implement a bold tax restructuring that encourages legal work in the formal economy, savings and investment, a flat-tax system set at 15% of income, and an ITBIS (VAT) tax of no more than 8%.
Hanke attributes the economic crisis to the government?s botched handling of the 2003 banking crisis. At the time, the government chose to bailout all depositors, despite the existence of a RD$500,000 limit established in legislation from 2002. He explains how the government opted to saddle Dominican taxpayers with the burden despite the fact that 80 depositors at the bank accounted for 75% of the total monies. He also explains that to finance the direct costs of the Baninter bailout, the government resorted to the classic measures: printing money, contracting more debt and raising tax rates. As a result, inflation surged, currency depreciated, banks raised interest rates and there was a general breakdown of public confidence in the ever-shrinking economy.
As a solution, Hanke calls for ?a new Dominican monetary regime? as the heart of a bold set of reforms. He highlights that the quasi-fiscal operations in the Dominican Republic have resulted in the fiscalization of the Central Bank. ?To ensure future stability, the monetary and fiscal regimes must be separated. Moreover, a monetary regime that imposes a hard budget constraint on the fiscal authorities is necessary.?
Hanke favors any solution that is compatible with allowing Dominicans to conduct business in any foreign currency they choose, not just the dollar. ?Should the dollar, at some time in the future, start to become an unreliable currency, Dominicans would have the freedom to switch to other currencies that meet their needs better. Using the dollar as a monetary anchor would not be an end in itself; it would be a step toward greater competition and freedom in monetary matters.?
Hanke, a senior fellow at the Cato Institute (public policy research) in Washington, D.C., says his recommendations are ambitiouns but feasible. He writes: ?Indeed, Russia adopted similar measures in January 2001. The results have been good: tax compliance has improved; incentives to work, save and invest have improved; and government revenues from the new, flat personal income tax have increased by almost 80 percent in real terms.?
For the entire executive summary of the study, see http://dr1.com/news/2004/072104_hanke.pdf
To contact the author, write to hanke@jhu.edu