1 June,2024 Guatemala Public Finance Review 2 Macroeconomics, Trade and Investment © 2024 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Guatemala Public Finance Review. © World Bank.” Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. 3 GUATEMALA PUBLIC FINANCE REVIEW P179444 Contents I. Execu ve Summary .............................................................................................................................. 9 II. Introduc on ........................................................................................................................................ 19 III. Revenue .............................................................................................................................................. 22 A. Overview ........................................................................................................................................ 22 B. Literature Review ........................................................................................................................... 23 C. Drivers of Tax Revenue ................................................................................................................... 24 D. Tax Revenue and Tax Policy Benchmarking .................................................................................... 25 E. Tax Administra on Benchmarking ................................................................................................. 35 F. Recommenda ons ......................................................................................................................... 36 IV. Public Financial Management ............................................................................................................ 41 A. Overview ........................................................................................................................................ 41 B. Performance-Based Budge ng ...................................................................................................... 43 C. Integra ng Climate Commitments into the Budget ....................................................................... 57 V. Fiscal Risks .......................................................................................................................................... 63 A. What are Fiscal Risks? .................................................................................................................... 63 B. Implica ons for Fiscal Policy .......................................................................................................... 64 C. Fiscal Risks in Guatemala ............................................................................................................... 65 D. Recommenda ons for Strengthening the Management of Fiscal Risks ........................................ 76 VI. References .......................................................................................................................................... 80 4 Figures Figure 1. Central government revenues, expenditures, and deficits 2015-2024 (% of GDP): .................... 20 Figure 2. Central government debt, 2015-2024 (% of GDP) ....................................................................... 20 Figure 3. Central government expenditures by economic classifica on, 2015-2024 (% of GDP) ............... 20 Figure 4. Central government social spending, 2015-2024 (% of GDP) ...................................................... 20 Figure 5. Central government debt forecast, baseline scenario, 2023-2029 (% of GDP)............................ 21 Figure 6. Central government debt forecast, alterna ve scenario, 2023-2029 (% of GDP)........................ 21 Figure 7. Tax revenue, 1990-2022 (% of GDP)............................................................................................. 22 Figure 8. The tax structure, 1990-2022 (% of GDP)..................................................................................... 22 Figure 9. Tax revenue (% of GDP) and per capita GDP (current US$), Guatemala and peers, 2022 ........... 24 Figure 10. Tax revenue (% of GDP) and indicators of government effec veness, Guatemala and peers, 2022 ............................................................................................................................................................ 24 Figure 11. Tax revenue, Guatemala and peers, 2013-22 average and 2022 (% of GDP) ............................. 26 Figure 12. Tax structure, Guatemala and peers, 2022 (% of total) ............................................................. 26 Figure 13. PIT revenue, Guatemala and peers, 2013-22 average and 2022 (% of GDP) ............................. 26 Figure 14. Top PIT rate, Guatemala and peers, 2010-23 (%) ....................................................................... 26 Figure 15. Marginal PIT rate, Guatemala, El Salvador, and Chile (% of 2021 GDP per capita) .................... 26 Figure 16. Effec ve PIT rate, Guatemala, El Salvador, and Chile (% of 2021 GDP per capita) ..................... 26 Figure 17. CIT revenue, Guatemala and peers, 2013-22 average and 2022 (% of GDP): ............................ 28 Figure 18. Top CIT rates, Guatemala and peers, 2010-23 (%) ..................................................................... 28 Figure 19. Statutory and effec ve tax rates, Guatemala and peers (%)...................................................... 28 Figure 20. CIT tax expenditures, Guatemala and peers (% of GDP and % of CIT revenues) ....................... 28 Figure 21. Property tax revenue, Guatemala and peers, 2013-22 average and 2022 (% of GDP) .............. 31 Figure 22. Real estate tax rate, Guatemala and peers (%) .......................................................................... 31 Figure 23. Average VAT revenues, Guatemala and peer groups, 2013-22 (% of GDP)................................ 32 Figure 24. VAT rates, Guatemala and peer groups, 2010-2023 (%) ............................................................ 32 Figure 25. VAT tax expenditures, Guatemala and peers, (% of GDP and % of VAT revenues) .................... 33 Figure 26. VAT rates, Guatemala and CADR countries (%) .......................................................................... 33 Figure 27. Excise tax revenues Guatemala and peers, 2013-2022 average (% of GDP) .............................. 34 Figure 28. Environment-related tax revenues (% of GDP) and net effec ve carbon rate (€/tCO2e), Guatemala and peers .................................................................................................................................. 34 Figure 29. Tax agents per 100,000 people and opera ng expenditures as a share of GDP, Guatemala and peers, 2021 or latest available data ............................................................................................................ 35 Figure 30. Large taxpayers/tax agents and revenue administered by the LTO as a share of net revenue, Guatemala and peers, 2021 or latest available data................................................................................... 35 Figure 31. On- me filling rate, Guatemala and peers, 2021 or latest available data (%) ........................... 36 Figure 32. PEFA scores for revenue management, Guatemala, Costa Rica, and El Salvador ...................... 36 Figure 33. Public expenditures as a share of GDP and in per capita terms (constant LCU), 2014-2024..... 41 Figure 34. Expenditures by func on, 2015-2024 (% of GDP)...................................................................... 41 Figure 35. Planning and budge ng under the GpR ..................................................................................... 47 Figure 36. Climate-relevant public investment by sector ........................................................................... 60 Figure 37. Climate-relevant public investment by agency type .................................................................. 61 Figure 38. Shares in public corpora ons as a percentage of total assets, 2021 ......................................... 71 Figure 39. SOE revenue distribu on, 2021 (GTQ millions).......................................................................... 71 5 Figure 40. Damage and Losses Caused by Severe Events, 1975-2015 ........................................................ 74 Tables Table 1. Policy recommenda ons ............................................................................................................... 14 Table 2. Statement of government opera ons (Budgetary Central Government) - % of GDP ................... 18 Table 3. PIT deduc ons, Guatemala, El Salvador, and Chile........................................................................ 27 Table 4. Income (withholding) tax rates, Guatemala and peer countries ................................................... 27 Table 5. Excise tax rates on selected products, Guatemala and peers........................................................ 34 Table 6. Interna onal comparisons of selected features of performance-based budge ng ...................... 54 Table 7. Recommenda ons ......................................................................................................................... 57 Table 8. Fiscal risk matrix ............................................................................................................................ 64 Table 9. Es mates of explicit and con ngent liabili es (% of 2021 GDP) ................................................... 67 Table 10. Por olio of PPP Ini a ves as of 2022 .......................................................................................... 69 Table 11. Financial statement of municipal and na onal public corpora ons (GTQ and % of GDP) .......... 70 Table 12. Government transfers granted to na onal non-financial public companies 2018-2021 (GTQ millions)....................................................................................................................................................... 72 Table 13. Financial liabili es and non-guaranteed debt from municipali es (% of revenues and % of GDP) .................................................................................................................................................................... 73 Table 14. Disaster risk profile for Guatemala .............................................................................................. 75 Table 15. Summary of scenarios by disaster type ....................................................................................... 75 Table 16. Summary of recommenda ons ................................................................................................... 78 Boxes Box 1: What is Pillar Two of the Global Minimum Tax Agreement? ........................................................... 29 Box 2. Good prac ces for SME tax regimes ................................................................................................ 39 Box 3. Performance Terminology in GpR .................................................................................................... 44 Box 4. Credit Risk Valua on for Assigning Guarantees in Colombia ........................................................... 68 Box 5. Managing Con ngent Liabili es from PPPs in Colombia ................................................................. 70 6 List of Acronyms AGRIP Risk Management Analysis for Public Investment Projects (Análisis de Ges ón de Riesgo en Proyectos de Inversión Pública) ANADIE Na onal Agency for Partnerships of Economic Infrastructure Development (Agencia Nacional de Alianzas de Desarrollo de Infraestructura Económica) BANGUAT Central Bank of Guatemala (Banco de Guatemala) CADR Central America and Dominican Republic CCRIF Caribbean Catastrophe Risk Insurance Facility CG Central Government CGC General Controller’s Office (Contraloría General de Cuentas) CIT Corporate Income Tax (Impuesto sobre la Renta, Empresas) CNCC Na onal Climate Change Council (Consejo Nacional de Cambio Climá co) CONRED Na onal Coordinator for Disaster Reduc on (Coordinadora Nacional para la Reducción de Desastres) CRI Global Climate Risk Index DCP Debt Management Office (Dirección de Crédito Público) DEA Data Envelopment Analysis DICABI Office for Cadaster and Evalua on of Immovable Property (Dirección de Cadastro y Avaluo de Bienes Imuebles) DSA Debt Sustainability Analysis EMPAGUA Municipal Water Enterprise of Guatemala City (Empresa Municipal de Agua de la Ciudad de Guatemala) EMPORANC Na onal Port Enterprise of Santo Tomás de Cas lla (Empresa Portuaria Nacional de Santo Tomás de Cas lla) EPQ Port Enterprise of Quetzal (Empresa Portuaria Quetzal) FHA Ins tute for the Promo on of Insured Mortgage (Ins tuto de Fomento de Hipotecas Aseguradas) GDP Gross Domes c Product GG General Government GHG Greenhouse Gas GLoBE Global An -Base Erosion Rules GMT Global Minimum Tax GpR Performance-Based Budge ng (Ges ón por Resultados) IGSS Guatemala’s Social Security Administra on (Ins tuto Guatemalteco de Seguridad Social) IMF Interna onal Monetary Fund INDE Na onal Ins tute of Electricity (Ins tuto Nacional de de Electrificación) INFOM Municipal Development Ins tute (Ins tuto de Fomento Municipal) INSIVUMEH Na onal Ins tute of Seismology, Volcanology, Meteorology and Hydrology ( Ins tuto Nacional de Sismología, Vulcanología, Meteorología e Hidrología ) ISORA Interna onal Survey on Revenue Administra on LAC La n America and Caribbean LOP Organic Budget Law (Ley Orgánica de Presupuesto) LTO Large Taxpayer Office MARN Ministry of Environment and Natural Resources (Ministry of Environment and Natural Resources) MFP Ministry of Finance (Ministerio de Finanzas Públicas) MNE Mul na onal Enterprise MTBF Medium-Term Budget Framework NDC Na onally Determined Contribu ons PANCC Na onal Climate Change Ac on Plan (Plan de Acción Nacional de Cambio Climá co) PEFA Public Expenditure and Financial Accountability PEI Institutional Strategic Plan (Plan Estratégico Institucional) 7 PFR Public Finance Review PGG General Government Plan (Plan General de Gobierno) PIT Personal Income Tax (Impuesto sobre la Renta, Persona Natural) POA Annual Operating Plan (Plan Operativo Anual) POM Multiannual Operating Plan (Plan Operativo Multianual) PPP Public-Private Partnership SAT Superintendent for Tax Administra on (Superitendencia de Administración Tributaria ) SCD Systema c Country Diagnos c SEGEPLAN Secretariat of Planning and Programming of the Presidency ( Secretaria de Planificación y Programación de la Presidencia) SIAF Government Financial Management Integrated System (Sistema Integrado de Administración Financiera) SICOIN System of Integrated Accoun ng SME Small and Medium Enterprises SNIP Na onal Public Investment System (Sistema Nacional de Inversión Pública) SOE State-Owned Enterprise VAT Value-Added Tax WB World Bank WDI World Development Indicators 8 I. Execu ve Summary Guatemala has developed a track record of prudent fiscal policy, but it has large spending needs. 1. Reflecting its track record of fiscal responsibility, Guatemala’s sovereign risk rating is the lowest in Central America. The budgetary central government1 (GG) budget deficit averaged 1.3 percent of GDP from 2021 to 2024,2 and the public debt stock was low at 26.4 percent of GDP in 2024. The country is currently rated one notch below investment grade by Moody’s and two notches by S&P and Fitch, with S&P recently changing its outlook to positive.3 Rating agencies highlight Guatemala’s “manageable fiscal deficits, very low net debt, strong external profile, and history of sound monetary policy,”4 as well as its “history of prudent fiscal management [and] continued macroeconomic stability despite external shocks.”5 As a result, since the end of 2023 Guatemala has had the lowest sovereign risk among Central American countries, including Panama, which has an investment grade rating. 2. The government’s key challenge is to increase infrastructure investment and social spending to boost growth and reduce poverty without jeopardizing fiscal responsibility. Guatemala’s revenues and expenditures are too low for the country to close its wide infrastructure gap and accelerate poverty reduction.6 Between 2021 and 2024, budgetary central government revenues and expenditures averaged 12.8 and 14.6 percent of GDP, respectively. Public investment was low at an average of 0.5 percent of GDP7, far below the levels of peer countries.8 From 2021 to 2024, social spending —i.e., expenditures on education, health, and social protection— averaged 6 percent of GDP and accounted for 43 percent of total spending. By contrast, social spending in other countries in Central America and the Dominican Republic (CADR) averaged 8.6 percent of GDP over the same period.9 Guatemala’s poverty, inequality, and child-malnutrition indicators are among the worst in the region. The government and the private sector have recognized the urgent need for infrastructure investment in the Guatemala Moving Forward (Guatemala no se Detiene) plan, while the current president has promised to build secondary roads and ensure that rural roads stay open year-round. 1 Guatemala’s fiscal deficit at the general government level, which includes the social security and the municipalities, was 1.5 percent of GDP on average from 2019 to 2023. 2 GDP and fiscal figures for 2023 are provisional. 3 Research Update: Guatemala Outlook Revised to Positive on Sustained Macroeconomic Resilience: ‘BB/B’ ratings Affirmed, S&P Global Rating April 18, 2024. 4 Idem. 5 Government of Guatemala – Ba1 Stable, Moody’s December 13, 2022. 6 Over half the population lives below the poverty line ($6.85, 2017 PPP), and average GDP per capita growth from 2013-22 was 1.9 percent, in line with structural and aspirational peers (1.8 and 2.0 percent respectively), but below CADR and Upper-middle- income countries with 2.3 and 3.6 percent respectively. 7 The same numbers for the general government are 15.8 percent of GDP (revenues), 17.3 percent of GDP for expenditures; and 2.2 percent of GDP for investments. 8 Guatemala’s country peers are the same used for the 2015 Systematic Country Diagnostic for consistency, namely structural peers are Bolivia, El Salvador, Honduras, Nicaragua, Paraguay; and Senegal, while aspirational peers are Chile, Latvia, Lithuania; and Panama. The criteria used for structural peers were: (i) low-middle income countries, (ii) population between 5 and 25 million people, (iii) share of agriculture in GDP value added below 20 percent, and (iv) exclusion of any small-island countries. For the aspirational peers, the criteria used were: (i) low-middle and high-middle income countries, (ii) per capita GDP growth rate above 3 percent, (iii) inflation rate below 5 percent, (iv) infant mortality below 100 (per 100,000 births), (v) population below 35 million people; and (vi) exclusion of any small-island countries. The criteria were set using average data from 2001- 2013. 9 These numbers come from the GFS/IMF fiscal database and are used to ensure comparability across countries and therefore can be different from local numbers due to methodological issues. 9 Guatemala needs to increase revenues in an efficient and fair way to meet its spending needs. 3. Guatemala will not be able to significantly scale up public investment, improve social outcomes, and preserve fiscal responsibility for a sustained period without mobilizing more revenue. In the baseline scenario,10 which allows for a modest expenditure increase, budget deficits are kept at an average of 2 percent of GDP during 2024-29, the debt-service-to-revenue ratio averages 14.4 percent over the period, and the public debt-to-GDP ratio stabilizes at about 28 percent by 2029. A debt-to- GDP ratio below 30 percent is compatible with investment-grade status, but the debt-service-to- revenue ratio would have to be below 12 percent to conform to Moody’s methodology. 11 If the government choses to increase public investment and social expenditures by 1.2 percentage points of GDP for the next five years with no offsetting cuts to recurrent spending, the public debt stock would rise to 36.1 percent of GDP by 2029, while the debt-service-to-revenue ratio would climb to 16.3 percent—both of which are inconsistent with the criteria for investment grade.12 While Guatemala can modestly increase expenditures permanently without risking fiscal sustainability, the larger and sustained expenditure increase needed to finance infrastructure investment and social spending could threat fiscal sustainability if financed solely through debt. Moreover, the analysis shows that the key constraint on the accumulation of debt is not debt-carrying capacity (i.e., the debt- to-GDP ratio), but rather payment capacity (the debt-service-to-revenue ratio), which can only be improved by increasing revenue or reducing the effective interest rate on the public debt. As there is little scope for the latter, increasing expenditures sustainably over time will require a permanent increase in revenue. 4. Guatemala has scope to increase its tax revenue by 2-3 percentage points of GDP. In 2022, tax revenue13 amounted to 14.4 percent of GDP, the third lowest share in the CADR after Panama at 13.2 percent and DR at 13.9 percent. Only 15 of 95 middle-income countries have tax-revenue-to-GDP ratios below 15 percent, which some analysts regard as the minimum level for the state to fulfill its critical functions.14 Moreover, Panama received 3.3 percent of GDP in non-tax revenues, mainly from the Panama Canal, making Guatemala effectively the country with the second lowest revenue share in the region, far below the averages for the CADR (18.6 percent of GDP), structural peers (20.5 percent), and aspirational peers (23.9 percent). Guatemala’s revenue challenges are longstanding, and from 2013 to 2022 its average revenues were below the averages for the CADR, structural peers, and aspirational peers. 5. The analysis presented in this Public Finance Review (PFR) reveals a range of opportunities for Guatemala to increase tax revenues fairly and efficiently. Most of these opportunities involve the personal income tax (PIT), corporate income tax (CIT), value-added tax (VAT), and excise taxes, with policy options focused on altering rate structures and reforming tax expenditures. Key recommendations are summarized below and detailed in Table 1. The proposed reforms would 10 The debt sustainability analysis (DSA) is done at the CG level due to the lack of consolidated debt data for the GG. Initial estimates show that carrying out the DSA at GG level would be beneficial to the debt-carrying capacity and rating. Both scenarios assume a GDP growth of 4 percent and a deflator of 2.9 percent. 11 It should be noted that sovereign-rating analysis considers many other factors, and a country can be rated investment grade despite having these two ratios outside of the investment-grade range, while the opposite is also true. 12 This alternative scenario does not include any second-order effect on growth from higher investment and social expenditures. 13 This report uses the general government tax burden that includes all taxes and social contributions collected by all levels of government and uses the global revenue database from OECD/IDB/CIAT. 14 See, e.g., (Barro, 1998) and (Varela, Gallardo, & Bustamante, 2020). 10 increase revenues by raising the productivity of the most efficient taxes, like the VAT, and by reducing exemptions for specific sectors that alter relative prices in the economy. In addition to efficiency, these reforms have an important equity component, as they aim to increase the structural progressivity of the tax system.  PIT. Increasing the PIT rates from their current very low levels of 5 and 7 percent, while also reducing or capping tax allowances, would boost revenue and improve progressivity.  CIT. The CIT rate is close to the levels of structural and regional peers, but tax expenditures consume 30 percent of CIT revenue, sharply lowering the effective rate. As the adoption of the Global Minimum Tax (GMT) will likely erode the benefits of CIT tax expenditures, the government should proactively revise and streamline tax expenditures in a manner consistent with the GMT.  Property tax. This tax base is underutilized, but the potential to increase revenue from property taxation is modest, at least in the near term. Tax rates are in line with those of peer countries, and revenue gains would come from improved cadastral registration and asset valuation. Property taxes tend to be progressive, as asset ownership is concentrated among wealthier households.  VAT. Guatemala’s VAT is broadly well designed, with a single rate and few exemptions. However, the VAT rate is below the levels of structural and aspirational peers and is the lowest in the region after Panama’s, while tax expenditures consume near 40 percent of VAT revenue. Extending the VAT to cover private education services and digital services would reduce tax expenditures and boost revenues, and a small increase in the tax rate could also be considered, assuming adequate compensatory measures were adopted to protect the welfare of poor households.  Excise taxes.15 Excise tax rates are low and outdated, and the tax base could be broadened to include goods that generate negative climate impacts and public-health externalities. Adjusting excise rates by past inflation would have the greatest revenue impact while also yielding indirect benefits by reducing pollution and improving public health and productivity. 6. Increasing tax revenues will require legislative reforms that must be supported through a robust political consensus. The absence of significant tax reforms in recent years and the current government’s pledge not to increase taxes indicate a current political consensus in favor of a low tax burden. Most of the tax reforms proposed in this PFR would require a political coalition to champion them, along with an effective communication campaign. While tax reform is a challenging process, useful lessons can be drawn from countries that managed to sustainably increase their revenue-to- GDP ratios over time.16 The first lesson is the need to communicate, engage, and promote dialogue around the importance of greater tax revenues and the opportunity costs that the low tax burden imposes on society. Stakeholders should be encouraged to consider the fiscal social contract, which describes what the public would receive in exchange for paying higher taxes. The proposed tax reforms could include features such as (temporary) earmarking and sunset clauses to help build consensus. Detailed fiscal policy analysis conducted by a skilled fiscal policy office could also facilitate coalition-building by simulating the impacts of the proposed reforms, including revenue gains, changes in poverty and inequality, and adjustments in the relative share of the tax burden across firms 15 Excise taxes are levied on the unit of a specific product in a predefined and limited range of goods. In Guatemala, taxes on petroleum and fuel, cement, on alcoholic and carbonated beverages, on tobacco, on international departures and on lodging, and the tax on vehicle’s first registration are considered excise taxes. 16 More information on this can be found on (Martinez-Vasquez, 2022) and on (Flores-Macías, 2016). 11 and households. A long-term process of communication, analysis, and dialogue can build reform momentum and overcome opposition from vested interests. The authorities could also consider establishing a tax commission representing all segments of society that would design the reform program with support from the government’s fiscal policy office. 7. Any changes to fiscal policy must be anchored in credible, well-communicated medium-term plans. The government has a range of options for increasing public investment and improving social outcomes, but not all of them are consistent with achieving investment-grade status and the benefits of lower borrowing cost and higher private investment that it brings and eventually higher growth. Outreach and accountability are essential to maintain a prudent fiscal stance. The government should lay out a clear medium-term plan with targets for current and capital spending, as well as a defined mix of financing sources, such as additional revenue, improved expenditure efficiency, and debt. This plan could take the form of a medium-term expenditure (or fiscal) framework and a medium-term debt strategy. These plans should be communicated effectively both to domestic and international stakeholders, with appropriate accountability and adjustment mechanisms to reflect changes in the external environment. Enhancing expenditure efficiency is the first step in strengthening fiscal policy. 8. Greater expenditure efficiency can help forge a consensus for tax reform. Opponents of tax increases often cite the dearth and low quality of infrastructure and public services. This is an appeal to the so- called social fiscal contract, which is the link between the taxes paid by firms and households and the public goods and services provided by the government. Transparent and accountable efforts to improve the efficiency of public spending, with clear output indicators and results targets, can help build a consensus for tax reforms. 9. An initial exploratory analysis highlights several areas in which public spending in Guatemala is especially inefficient. Delays in obtaining detailed expenditure data at the GG level, as well as detailed administrative data to calculate the input-output efficiency scores, prevented a thorough analysis of expenditure efficiency as part of this PFR.17 However, an exploratory efficiency analysis18 conducted at the aggregated expenditure level was used to benchmark Guatemala against peer-group averages. For health and infrastructure spending, the efficiency analysis is based on combined public and private expenditures. The main findings for the education, health, and infrastructure sectors are summarized below. 17 The team is working with the new administration to carry out a joint analysis. 18 Technical inefficiency, which is measured here, happens when more inputs are used than what is technically required to obtain a given level of output. Allocative efficiency can be defined in two dimensions. The first one at a more macro level is “the delivery by the government of the mix of different types of services, which most closely reflect social priorities, based on society’s valuations of output choices” ” (Robinson, 2007) The second definition of allocative efficiency comes from a microeconomics perspective requires that public goods and services be produced with the set of minimum inputs required (within the isoquant curve) and with the least cost combination of inputs. Technical efficiency is calculated using five different methods and their average. The first two methods are data envelopment analysis (DEA) and Free Disposal Hull (FDH). These methods are non-parametric, i.e. they do not assume a specific functional form for the relationship between inputs and outputs and are deterministic because they assume that all deviations from the frontier come from inefficiencies. Because DEA and FDH are subject to sampling variation and can be affected by outliers, a bootstrapped version of both techniques is also used. Bootstrapping mimics the data generation process to create replicate samples for estimating parameters like efficiency, mitigating sample problems and the potential bias of assuming that the most efficient unit is present in the original sample. The fifth method is the stochastic frontier analysis, which is parametric and assume that deviations from the frontier come from both inefficiencies and random effects. 12  Education. Guatemala’s average output-oriented efficiency score for education spending is 65.9, well below the regional, structural, and aspirational peer averages of 75.2, 68.8, and 84.7, respectively. Guatemala is much closer to the frontier for indicators related to primary education, such as the gross and net primary enrollment rates (77 and 88.5 percent, respectively) and the youth literacy rate19 (93.9 percent). However, indicators related to secondary schooling or long- term schooling show a higher efficiency gap. The output-oriented scores for net secondary enrollment, average years of schooling, and overall acquisition of education and skills are 47.1, 37 and 69.3 percent, respectively.  Health. Although Guatemala is below the efficiency frontier, its combined outcome-oriented efficiency score for health spending is 90.1, indicating only modest scope to improve efficiency. Guatemala’s weakest indicator is infant survival (83.3) and its strongest is maternal survival (94.1).  Infrastructure. Guatemala’s score for infrastructure spending (49.3) is well below the frontier, but it ranks between the average for structural peers (46.62) and the average for regional peers (54.43). Despite considerable room to improve efficiency, Guatemala’s indicators are broadly in line with those of comparable countries. However, expenditure efficiency varies across infrastructure subsectors. While Guatemala is very close to the frontier and leads its peers in terms of spending on electricity infrastructure, it has the lowest scores for overall transportation (38.3) and roads (28.7) and the second lowest score for ports (35.7). 10. Guatemala has long utilized performance-based budgeting, but this approach could be strengthened and refocused on enhancing expenditure efficiency. The government began implementing performance-based budgeting, known locally as gestión por resultados (GpR) in 2013, and it is now used across the public sector. The key strengths of GpR include its supporting infrastructure (laws, policies, IT systems), integration with planning tools, and good use of program- based budgeting. However, expenditure prioritization does not consider previous commitments and is done prior to the preparation of budget, and thus is financially unconstrained, leading to ad hoc cuts and target resetting during budget formulation and execution. GpR uses a range of performance indicators and targets, but most of these are flawed. Evaluations are limited, and outcome data are not systematically integrated into future spending decisions. Guatemala would benefit from simplifying the planning process, synchronizing budgeting with expenditure prioritization, and focusing on a narrower set of high-quality performance indicators. Incorpora ng climate change dimensions into fiscal policy is crucial to build resilience. 11. Climate change can reduce expenditure efficiency and undermine fiscal sustainability through multiple channels. The rising frequency and intensity of natural disasters directly increases reconstruction and compensation costs. Climate change and the energy transition require greater investment in renewable energy, battery storage, and other forms of green infrastructure while altering the composition of the tax base as fossil fuel consumption declines and electricity demand increases. Climate change also affects expenditure policy, as social protection programs need to include compensation for people vulnerable to natural disasters. Climate change can alter the health- risk profile and require infrastructure to be built in a more resilient way, increasing demands on the budget explicitly or via contingent liabilities. 19 Youth literacy is defined by the share of population aged 15 to 24 that can read and write. 13 12. Guatemala has made important efforts in creating a policy framework for climate change. However, government agencies have yet to fully assume their responsibilities, and ownership of the policy framework is weak. The government still lacks an effective instrument to translate its climate framework into corresponding budget allocations, and funding remains heavily dependent on donor contributions. Modest, gradual changes—such as providing practical training to governmentwide budget officers and adopting clear monitoring and reporting mechanisms—could help overcome these challenges. Rebalancing Guatemala’s fiscal policy is essen al to accelerate growth. 13. Strengthening the management of fiscal risks, including those arising from climate change, will enable greater infrastructure investment and support investment-grade status. Although not legally mandated by a congress-approved law20, the government undertakes an annual review of fiscal risks, that has improved significantly in recent years. However, this review does not include some risk sources such as climate change. Moreover, the government does not quantify all potential costs and liabilities, nor does it estimate the probability of risks materializing or have mechanisms in place to manage them. Guatemala should establish a comprehensive legal and institutional framework to estimate, manage and report fiscal risks while implementing risk-mitigation and monitoring mechanisms. 14. Multiple aspects of Guatemala’s fiscal policy are already sound, but small changes could enable the country to achieve better outcomes. Guatemala has a record of fiscal discipline and consistency over time, as well as the ability to conduct countercyclical policy, but reforms could allow the country to provide more public services and infrastructure, carry more debt sustainably, and support growth and poverty reduction. Key changes include a moderate increase in tax revenues in line with regional and structural peers and concerted efforts to improve the efficiency of public service delivery. These reforms must be anchored in a credible, accountable, and well-communicated medium-term fiscal strategy. On a more structural level, efforts are needed to mainstream climate change into the budget process, improve GpR to serve as an effective tool for expenditure efficiency, and adopt comprehensive fiscal risk management. Table 1. Policy recommenda ons21 # Area Recommenda on Fiscal Impact on Timeframe Impact poverty (% of and GDP) inequality 1 Debt Publish in centralized and accessible manner Transparency detailed me-series data on the general government’s debt, revenues, and expenditures in Neutral Neutral Short Term line with interna onal standards to allow ra ng agencies and investors to assess sovereign risk. 2 Fiscal Policy Improve the communica on of a credible and accountable medium-term expenditure or fiscal Neutral Neutral Short Term framework laying out the government’s objec ves 20 The Ministry of Finance bylaws (reglamento orgánico) (Governmental Agreement 112-2018, Article 57) indicate that the Directorate of Fiscal Analysis and Policy, specifically the Macro-fiscal Department, must carry out the analysis of the main fiscal risks that affect the budget. 21 In addition to these recommendations, the World Bank is supporting the country with a technical assistance project to improve tax administration, which aims to increase tax revenue by up to 0.9 percentage points of GDP. 14 for the public debt and deficit, along with related revenue and expenditure measures and a medium-term debt strategy. 3 Revenue (PIT) Reform the PIT law to: (i) increase tax rates and brackets judiciously based on micro-simula ons with household survey data, (ii) consolidate all income sources—wages, dividends, rent, etc.— Medium and apply a single progressive tax schedule; and 0.3-0.5 Posi ve Term (iii) reduce tax allowances, ideally allowing deduc ons only for mandatory social security contribu ons or at least capping the most regressive deduc ons. 4 Revenue (PIT) Introduce a high-net-worth individuals’ program with a dedicated team focused on taxpayers who Posi ve have more ways to evade and gain from tax Short to but not arbitrage, sourcing third-party data to prefill PIT Posi ve Medium quan fi returns and strengthen interna onal tax Term able coopera on to obtain informa on on foreign assets and income. 5 Revenue (Tax Review tax-expenditure framework with the aim expenditures, of reducing them by making the following changes CIT) by: (i) commissioning an external review to assess Posi ve methodological choices in the es ma on of tax but not Medium to expenditures, (ii) requiring all tax expenditures to Posi ve quan fi Long Term have an explicit and measurable objec ve, and (iii) able evalua ng all tax expenditures within a set meframe to determine their full costs and benefits. 6 Revenues (Tax Review tax expenditures granted to mul na onal expenditures, enterprises opera ng in free-trade zones to assess Short to CIT) their compa bility with GLoBE rules and define a 0.1 Posi ve Medium strategy to avoid losing revenues to other Term jurisdic ons. 7 Revenues Improve CIT enforcement by including more Posi ve, (CIT) companies in the Large Taxpayer Office and by but not Posi ve Short Term increasing use of third-party data and the quan fi interna onal exchange of informa on. able 8 Revenues Improve the na onal property cadaster by using a (Property) state-of-the-art geographic informa on system to Medium to iden fy proper es, leveraging real estate 0.2 Posi ve Long Term transac on data to inform property valua ons, and expedi ng valua ons in high-value areas. 9 Revenues (Tax Task the Superintendent for Tax Administra on Posi ve Admin.) (SAT) with collec ng social security contribu ons, but not managing the property cadaster, and Neutral Long Term quan fi administering municipal property taxes for the able municipali es done by DICAB. 10 Revenues Impose VAT on digital services and low-value (VAT) goods imported by consumers by: (i) amending Medium the legal framework to clarify that VAT on digital 0.1 Neutral Term trade is levied in the place of the consumer’s usual residence, (ii) require that digital providers and 15 pla orms collect and remit VAT on behalf of their clients; (iii) create simplified registra on and payment mechanisms for nonresident digital providers; and (iv) use third-party tax withholding to backstop enforcement as needed. 11 Revenues (Tax Increase VAT revenues by imposing VAT on fee- Medium expenditures, based financial services and private educa on 0.3 Posi ve Term VAT) services. 12 Revenues Increase excise tax revenue by: (i) adjus ng the Nega ve (Excise) values of taxes on fuels and so drinks to account to neutral for infla on; (ii) authorize the Ministry of Finance if impact Medium 0.9 (MFP) to con nue adjus ng those taxes for on poor is Term infla on; and (iii) increase the tax on alcoholic compensa beverages to the level of peer countries. ted 13 Expenditure Carry out an expenditure-efficiency analysis with Efficiency data-envelopment, free disposal hull, and Posi ve Short to stochas c fron er techniques for the main but not Neutral Medium expenditure func ons, star ng with educa on at quan fi Term the local or budget-unit level to iden fy the most- able and least-inefficient units. 14 GpR Review performance indicators and replace the (Indicators) exis ng ones with: (i) more outcome indicators that report on the effec veness of specific programs or their intermediate outputs; (ii) more Medium to Neutral Neutral output quality indicators (e.g., meliness, client Long Term sa sfac on and compliance-with-service- standards); and (iii) more equity indicators (e.g., impact on gender and Indigenous Peoples). 15 GpR (M&E) Set targets only for selected performance indicators and strengthen the monitoring of Medium Neutral Neutral performance indicators to go beyond checking Term performance against targets. 16 GpR (M&E) Gradually implement selec ve and prac cal forms Medium Neutral Neutral of evalua on. Term 17 GpR (Budget Transform the medium-term fiscal framework into Framework) a full medium-term budget framework based on Medium the explicit recogni on of the difference between Neutral Neutral Term baseline and new spending and develop robust medium-term es mates of baseline expenditures. 18 GpR (Planning Simplify the planning process by reducing the use and of complex concepts that are not necessarily well Budge ng) understood and modify the planning and budget Neutral Neutral Long Term process to explicitly respect the budget constraint and ensure that expenditure priori za on reflects baseline and new spending. 19 Climate and Organize a series of prac cal trainings that help Budget ins tu ons iden fy the risks and opportuni es Short to (Training) around climate change, assess the vulnerability of Neutral Neutral Medium exis ng ac vi es, and iden fy appropriate Term adapta on approaches. 16 20 Climate and Conduct a survey to assess local governments’ Budget awareness of the use of the Municipal Planning (Surveys) for Climate Change (PLANIMUCC) tool, develop Neutral Neutral Short Term trainings for local governments, and improve the PLANIMUCC based on the results. 21 Climate and Develop a methodology for assessing the climate Budget (Risk vulnerability of proposed investment projects that Medium to Assessment) reflects the project’s sensi vity to hazards, the Neutral Neutral Long Term likelihood of each hazard occurring, and the poten al impact of each hazard on the project. 22 Climate and Create a par cipatory process to update the Budget Na onal Climate-Change Ac on Plan (PANCC) that Medium to Neutral Neutral (Planning) includes rigorous priori za on, financing Long Term arrangements, and the division of responsibili es. 23 Climate and Create a simple monitoring and repor ng Budget mechanism for climate ac vi es based on exis ng (Monitoring informa on systems for financial management and Neutral Neutral Short Term and public investment with results indicators and Repor ng) repor ng mechanisms. 24 Fiscal Risks Establish a comprehensive legal and ins tu onal Posi ve (Legal framework to define, es mate, manage, and but not Medium Framework) report fiscal risks, and establish risk mi ga on and Neutral quan fi Term monitoring mechanisms with clearly defined able responsibili es. 25 Fiscal Risks Develop procedures, capacity, and tools for Posi ve (guarantee) assessing credit risk in guarantees. but not Neutral Short Term quan fi able 26 Fiscal Risks Monitor and control the disbursements of loan (guarantee) guarantees and on-lending to state-owned Posi ve enterprises (SOEs) and municipali es based on but not Medium Neutral credit risk and differing fee and cost structures quan fi Term and include evalua on results in the fiscal risk able report. 27 Fiscal Risks Establish a methodology to quan fy explicit Posi ve (PPPs) con ngent risks from PPPs and their probability of but not materializing, and devise mechanisms to limit and Neutral Short Term quan fi manage these risks, including caps on total able expenses and on explicit con ngent liabili es. 28 Fiscal Risks Ins tu onalize credit risk assessments of SOE and Posi ve (SOE) ensure comparability across en es as part of the but not Neutral Short Term process for submi ng funding requests to the quan fi MFP. able 29 Fiscal Risks Produce annual audit reports for the largest and Posi ve (SOE) most strategically important municipal SOEs and but not Neutral Short Term publish them on the websites of each SOE and the quan fi MFP on a regular and mely basis. able 30 Fiscal Risks Adapt the Municipal Financial Management Index Posi ve (Municipal) to quan fy implicit con ngent liabili es and but not Medium assess their probability of materializing; use the Neutral quan fi Term results to create an early warning system for able implicit con ngent liabili es from municipali es; 17 and evaluate the applica on of formal and explicit limits on non-guaranteed municipal debt based on repayment capacity. 31 Fiscal Risks Conduct and publish regular analyses that (Climate) evaluate the magnitude of budgetary Posi ve expenditures for natural disasters; clearly iden fy Short to but not the sources of financing for these expenditures; Neutral Medium quan fi and es mate the frequency of events that would Term able require an increase in the ini ally programmed budget alloca ons. Table 2. Statement of government opera ons (Budgetary Central Government) - % of GDP 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024P Revenues 11.7% 12.0% 11.9% 11.8% 11.7% 11.1% 12.7% 12.9% 12.9% 12.8% Taxes 10.4% 10.4% 10.6% 10.6% 10.4% 10.0% 11.6% 11.8% 11.6% 11.6% PIT 0.4% 0.4% 0.5% 0.5% 0.5% 0.5% 0.7% 0.5% 0.5% 0.5% CIT 3.3% 3.4% 3.4% 3.3% 3.2% 3.1% 3.5% 3.7% 3.8% 3.8% Property Tax 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% VAT 4.9% 4.7% 4.9% 5.0% 5.0% 4.7% 5.5% 5.8% 5.5% 5.5% Excises 0.9% 0.9% 0.9% 0.8% 0.9% 0.8% 0.8% 0.8% 0.7% 0.7% Other taxes 0.9% 1.0% 1.0% 1.0% 0.9% 0.8% 1.0% 1.0% 1.0% 1.0% Social Contributions 0.7% 0.8% 0.8% 0.8% 0.8% 0.8% 0.7% 0.7% 0.7% 0.8% Other Revenues 0.6% 0.8% 0.4% 0.5% 0.5% 0.4% 0.4% 0.4% 0.6% 0.4% Expenditures 13.2% 13.1% 13.3% 13.7% 14.0% 15.5% 13.8% 14.6% 14.1% 13.7% Current Expenditures 12.7% 12.8% 12.9% 13.0% 13.1% 15.0% 13.3% 14.0% 13.5% 13.4% Payroll 4.6% 4.5% 4.7% 4.6% 4.8% 5.0% 4.6% 4.4% 4.3% 4.3% Goods and Services 1.7% 1.5% 1.3% 1.5% 1.4% 1.5% 2.0% 2.2% 1.9% 1.6% Interest Payments 1.6% 1.5% 1.5% 1.5% 1.6% 1.7% 1.7% 1.6% 1.6% 1.6% Transfers 3.2% 3.4% 3.6% 3.4% 3.4% 3.4% 3.2% 3.4% 3.6% 3.5% Other current expenditures 1.7% 1.8% 1.8% 1.9% 1.9% 3.4% 1.8% 2.4% 2.1% 2.3% Public Investments 0.4% 0.3% 0.4% 0.7% 0.8% 0.5% 0.6% 0.6% 0.6% 0.3% Net Operating Result -1.0% -0.8% -1.0% -1.2% -1.4% -3.9% -0.6% -1.1% -0.6% -0.6% Net Borrowing/ Net Lending -1.5% -1.1% -1.4% -1.9% -2.2% -4.4% -1.1% -1.7% -1.3% -0.9% Source: Ministry of Public Finance and Central Bank of Guatemala. Note: P= provisional. 18 II. Introduc on 1. Guatemala’s macroeconomic stability is a great developmental asset. Macroeconomic stability is a necessary condition for sustainable growth,22 and rating agencies have cited it as one of Guatemala’s key strengths.23 Between 2015 and 2019, real GDP growth averaged 3.5 percent, underpinned by prudent fiscal management and credible monetary policy. Inflation averaged 3.7 percent over the period, while the fiscal deficit averaged 1.6 percent of GDP. Meanwhile, private consumption was supported by rising remittance inflows, which now approach 20 percent of GDP. Guatemala weathered the shock of the pandemic relatively well, pursuing countercyclical fiscal and monetary policies while maintaining macroeconomic stability. GDP growth averaged 3.5 percent between 2020 and 2024, and while average inflation peaked at 6.9 percent in 2022 (9.2 percent end-of-period)—in line with global trends—it fell to an average of 2.9 percent by end-2024 (1.7 percent end-of-period). 2. Despite Guatemala’s macroeconomic stability, underlying challenges persist, including stagnant produc vity growth and insufficient human capital development. The country’s Human Capital Index edged up only slightly from 0.44 in 2010 to 0.46 in 2020. Human development outcomes are par cularly low among Indigenous Peoples, Afro-descendants, and rural communi es. Economic growth has been driven by capital accumula on and an expanding labor force, with the la er expected to increase un l 2044. However, the labor-force par cipa on rate remained rela vely low at 60 percent in 2022, especially among women. Poverty and inequality indicators have remained broadly unchanged over the last decade. Over half of the popula on lives below the poverty line,24 one of the highest rates in Central America and the Dominican Republic (CADR). The labor market is characterized by pervasive informality, with over 70 percent of the employed popula on working informally. This figure rises to nearly 75 percent among women, and informality is especially common in the agricultural sector. 3. Guatemala’s fiscal policy is characterized by low revenues, low expenditures, narrow fiscal deficits, and a modest public debt stock. Fiscal prudence is crucial to Guatemala’s macroeconomic stability and is reflected in its sovereign credit rating, which is the second highest in the CADR region after Panama’s. However, low spending levels have prevented the country from addressing key development challenges such as poor infrastructure, child malnutrition, and poverty. 4. Guatemala’s tax-revenue-to-GDP ratio is below the threshold of 15 percent of GDP that some analysists regard as the minimum level for a state to function effectively.25 Tax revenue averaged 13.1 percent of GDP from 2015 to 2019 but has risen in recent years, reaching 14.4 percent in 2022— albeit still about 7 percentage points of GDP below the Latin America and Caribbean (LAC) average. 26 Revenue mobilization has historically been constrained by multiple tax exemptions, unfavorable court 22 See (Barro, 1998) and (Varela, Gallardo, & Bustamante, 2020). 23 “Guatemala's 'BB' ra ng is supported by a track record of macroeconomic stability, conserva ve fiscal policies that have resulted in low government borrowing, and robust external liquidity” (Fitch Ra ngs, 2024) and Credit strengths: history of prudent fiscal management, con nued macroeconomic stability despite external shocks; and substan al workers’ foreign remi ances, more than 10% of GDP” (Moody's Investor Service, 2022). 24 Poverty is measured at US$6.85 per person per day in 2017 purchasing-power-parity terms. 25 Please see para 108 on (International Development Association, 2017). Guatemala would still be below the 15 percent-of- GDP-threshold, even if social security contributions and municipal taxes were included. 26 These numbers reflect the figures reported as tax revenues by the government for the central administration. It differs from the ones reported at the OECD/IDB/CIAT tax revenue database because the later includes social security contributions and other payroll taxes collected by decentralized agencies (INTECAP for vocational training and IRTRA for recreation) and municipal taxes, of which the property tax is the largest. 19 rulings, weak revenue administration, and the persistence of a large informal sector. Chapter 3 details the challenges posed by the country’s low tax-to-GDP ratio. 5. Public spending averaged 13.4 percent of GDP from 2015 to 2019, with current expenditures accounting for 96 percent of total spending. Public spending (budgetary central government) peaked at 15.5 percent of GDP in 2020, driven by the response to the COVID-19 crisis, then fell to 13.7 percent of GDP in 2024. Expenditures are countercyclical—the correlation between the cyclical component of GDP and expenditures is - 0.52—but expenditure rigidity has moderately increased, which might affect the government’s ability to conduct countercyclical fiscal policy in the future. The share of highly rigid expenditures, defined as payroll, interest payments, and social security benefits, declined from 52.7 percent in 2015 to 48.8 percent in 2024, while the share of high- and medium-rigidity expenditures, including social protection transfers, transfer to lower government levels, and half of spending on goods and services, increased from 84.4 to 82.5 percent, which was all within the expected range during the period. Figure 1. Central government revenues, Figure 2. Central government debt, 2015-2024 expenditures, and deficits 2015-2024 (% of (% of GDP) GDP): 18% 0% 35% 16% -1% 31.5% 30.6% 30% 29.0% 14% -1% 27.2% 26.5% 26.5% 26.4% -2% 24.9% 25.0% 25.2% 12% 25% -2% fiscal deficit 10% -3% 20% 8% -3% 15% 6% -4% 4% -4% 10% 2% -5% 5% 0% -5% 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0% Revenues Expenditures Fiscal Deficit 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Ministry of Public Finance Source: Ministry of Public Finance Figure 3. Central government expenditures by Figure 4. Central government social spending, 2015- economic classifica on, 2015-2024 (% of GDP) 2024 (% of GDP) 12% 16% 9.9% 14% 10% 12% 7.9% 7.9% 8.0% 7.9% 8.2% 7.3% 7.4% 7.6% 10% 8% 7.3% 8% 6% 6% 4% 4% 2% 0% 2% 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Wages Goods and Services Interest Payments 0% Transfers Other current expenditures Capital Expenditures 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Social Public Expenditures Health Education Social Protection Source: Ministry of Public Finance Source: Ministry of Public Finance 6. Low expenditure levels and lack of coordination hinder Guatemala’s ability to address complex challenges such as climate change. Despite its low contribution to global emissions, Guatemala is highly vulnerable to the impacts of climate change. The government has made important efforts to create a legal and policy framework for coping with climate change, but it still lacks an effective 20 instrument to allocate resources, and its current climate funding relies heavily on donor contributions. These issues are explored in greater depth in the final section of Chapter 4. 7. The budget deficit peaked at 4.4 percent of GDP in 2020 amid the pandemic, then fell to 0.9 percent in 2023, below the pre-pandemic average of 1.6 percent. The public debt27 averaged 25.6 percent of GDP during 2015-2019 and peaked at 31.5 percent in 2020 before easing to 26.4 percent in 2024. Although Guatemala’s debt level is modest vis-à-vis its peers, its low level of tax revenue results in a high debt-service-to-revenue ratio, which averaged 13 percent from 2015 to 2019 and 12.5 percent in 2024. 8. Guatemala’s debt trajectory is sustainable. The baseline scenario for the central government debt assumes an average GDP growth rate of 4 percent, an average fiscal deficit of 2 percent of GDP, and an average GDP deflator of 2.9 percent. These assumptions yield a stable debt-to-GDP ratio of about 28 percent, with average public gross financing needs of 3.6 percent of GDP over 2024-29. The debt- service-to-revenue ratio averages around 14 percent. The debt-sustainability analysis (DSA) is performed at the central government level due to a lack of consolidated debt data for the general government (GG). Initial estimates show that carrying out the DSA at GG level would be beneficial to the debt-carrying capacity and sovereign rating. Figure 5. Central government debt forecast, Figure 6. Central government debt forecast, baseline scenario, 2023-2029 (% of GDP) alterna ve scenario, 2023-2029 (% of GDP) 35% 40% 36.1% 34.8% 28.7% 28.7% 28.6% 35% 33.5% 30% 27.8% 27.9% 28.4% 28.4% 32.2% 30.7% 29.0% 30% 27.8% 25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% 2023 2024 2025 2026 2027 2028 2029 2023 2024 2025 2026 2027 2028 2029 Source: WB Staff projec ons Source: WB Staff projec ons 9. However, fiscal risks could impact debt sustainability in the medium term. Fiscal risks are estimated at around 4 percent of GDP. Fiscal risks arising from macroeconomic factors, public debt, local governments, and state-owned enterprises (SOEs) are low. The main social security scheme for private-sector workers is forecast to post its first cash deficit in 2024, but its reserves are expected to cover the deficit until 2032. Nevertheless, given the sensitivity of the issue and the considerable time required to approve pension reforms and rebalance its schemes, the system’s deficit should be regarded as a medium-priority fiscal risk.28 The government is also obliged to pay a large judicial settlement that has been increasing over time, though it still represents less than 1 percent of tax revenue. However, the government had more than 7,000 claims against it for a total of 1.7 percent of GDP in 2022, and this total does not include labor claims, which represent 94 percent of all claims. Finally, fiscal risks from natural disasters are extremely relevant to Guatemala, and mitigation 27Public debt includes central government debt and debt from decentralized government agencies with sovereign guarantee. 28 A 2022 WB report (Rudolph & Zviniene, 2022) on pensions in LAC noted that Guatemala’s pension system is very generous with a replacement rate above 70 percent of the salary, higher than OECD average and that men are spending five years or longer in retirement than other men globally. 21 mechanisms have been established, including a disaster risk finance strategy, catastrophe insurance, and contingent loans from multilaterals. 10. Despite Guatemala’s record of fiscal responsibility, fiscal risks deserve attention. Guatemala has made significant progress in identifying fiscal risks and expanding the coverage of its fiscal risk report, but it still does not include all sources of fiscal risk and lacks measures to manage risks affecting the central government and the line agencies. Moreover, the government is not legally required to identify, estimate, or manage fiscal risks, and a unilateral policy decision could halt these practices. Fiscal risks are the focus of Chapter 5. 11. This PFR is the first since 2013, and it complements other World Bank Group advisory support and analytics. The PFR updates the fiscal analysis with data from 2013 through 2023 and expands into areas not previously covered, such as revenues, fiscal risks, and performance-based budgeting. It also complements the ongoing CADR fiscal report (P179152). The PFR is organized into five chapters. Following the executive summary and the introduction, Chapter 3 presents an extensive benchmarking of tax policy and tax administration. Chapter 4 examines public financial management, starting with stylized facts, reviews the performance-based budgeting system with a view to improve expenditure efficiency, and considers how climate plans are incorporated in the budget. Chapter 5 reviews Guatemala’s practices for identifying, estimating, and managing fiscal risks. III. Revenue29 A. Overview 12. This chapter assesses the scope for additional revenue mobilization and identifies key opportunities. Revenue potential is gauged by analyzing the drivers of tax revenue, identified in the literature, and estimating tax capacity. Opportunities for increasing revenue are assessed by benchmarking revenues by tax base (income, profits, payroll, goods and services, property, etc.) and then comparing tax policy (rates and rules), tax expenditures, and tax administration practices using cross-country datasets and evidence from the empirical literature. A brief literature review is included to highlight the drivers of tax revenue and illustrate the link between revenue mobilization and socioeconomic development. Figure 7. Tax revenue, 1990-2022 (% of GDP) Figure 8. The tax structure, 1990-2022 (% of GDP) Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: OECD/IDB/CIAT Global Revenue Sta s cs 29This section uses data from the OECD/IDB/CIAT global revenue database to ensure comparability across countries. The OECD/IDB/CIAT revenue database includes municipal and social security revenues, but excludes royalties and fines from taxes. Thus, the numbers are different from the numbers reported by SAT for the budgetary central government. 22 13. Guatemala’s tax revenues have remained flat for almost 20 years, but recent data show an uptick. 30 Tax revenues increased from 7.9 percent of GDP in 1990 to 13.7 percent in 2002 but then fluctuated around 13 percent of GDP until 2019. In 2022, tax revenues peaked at a historic high of 14.4 percent of GDP. 14. Guatemala’s tax structure is concentrated on income taxes and value-added tax (VAT), and the share of revenue derived from these taxes has increased over time. In 2022, personal income tax (PIT) and corporate income tax (CIT) accounted for 24.2 percent of total tax revenues, while VAT accounted for 41 percent. The combined revenue share of these three taxes rose from 57.8 percent in 2000 to 65.2 percent in 2022. B. Literature Review 15. The literature finds a strong positive association between higher tax levels and development, although it stops short of establishing that greater tax revenue is a necessary condition for accelerated growth. This tradition dates to Joseph Schumpeter, who theorized about the existence of a state’s fiscal potential (Schumpeter, 1918), and Nicholas Kaldor, who found that “it is shortage of resources, and not inadequate incentives, which limits the pace of economic development” (Kaldor, 1963). More recent research (Gaspar, Jaramillo, & Wingender, 2016) has indicated the existence of a tipping point in tax revenue of between 12.4 and 12.9 percent of GDP, which if crossed would spur higher growth. The rationale is that tax revenues are associated with the government’s capacity to provide public goods needed to support economic development. 16. A rich strand of the literature focuses on the economic drivers of taxation and the difference in tax levels among countries and across time. The economic factors often cited as drivers of taxation and explanatory variables for cross-country and time differences include: (i) the association between wars and taxation (Besley & Persson, 2009), (ii) the correlation with income (Besley & Persson, 2014), (iii) increased trade openness, although this link has recently weakened (Gupta A. , 2007), (iv) financial- sector development (Gordon & Li, 2009); and (v) third-party reporting though firms (Kleven, Kreiner, & Saez, 2016). Factors that tend to undermine tax revenue include: (i) the relative size of hard-to-tax sectors like agriculture (Martinez-Vasquez, Alm, & Schneider, 2004), (ii) the relative size of the informal economy (La Porta & Schleifer, 2014); and (iii) the existence of easy-to-tax natural-resource endowments (Keller, 2022). Remittances have ambiguous impacts: they tend to increase tax revenue from consumption (Asatryan, Bittschi, & Doerrenberg, 2017) but can reduce revenue from production by diminishing the labor supply (Bussolo & Medvedev, 2008) and adversely affecting the fiscal contract (García & Maydom, 2021). Some studies have found that external aid negatively affects tax revenue (Besley & Persson, 2014), but others have failed to identify a clear relationship (Morrisey, 2015), and donor efforts to increase domestic revenue mobilization can offset negative effects. 17. Institutional factors also help explain variations in tax revenues across countries and time. One study found a strong positive correlation between constraints on executive powers and taxes, as well as between state effectiveness (measured as the perception of corruption and the protection of property rights) and tax revenue (Besley & Persson, 2009). Tax morale— a measure of the public’s willingness to pay taxes and respect tax laws—is also an important determinant of compliance. 30This chapter analyses general government’s tax revenues, which includes central and local governments, and the social security. These figures are around 3 percentages points of GDP higher than the figures for the central government. 23 18. An analysis of all tax-revenue drivers can enable the estimation of a country’s tax capacity and tax gap. Tax capacity is the potential tax revenue a country could collect based on its tax-revenue drivers. The tax gap is the difference between tax capacity and actual tax revenue. A positive tax gap indicates scope for a country to increase tax revenue. Empirical approaches include cross-country regression (Le, Moreno-Dodson, & Bayraktar, 2012) and frontier analysis (Fenochietto & Pessino, 2013). C. Drivers of Tax Revenue 19. Guatemala collects less tax revenue than its peers given its economic characteristics. An analysis of Guatemala’s tax drivers shows that it collects less revenue than would be predicted, even though its indicators for certain drivers, such as trade openness, are among the lowest in the region. Based on the average relationship between tax revenues and income per capita, trade openness, the size of the agricultural sector, and informality, Guatemala’s tax revenues were 6.8, 4.7, 8.0, and 5.8 percentage points of GDP lower than expected, respectively. 20. Tax revenue collection in Guatemala is lower than peers given its institutional characteristics. In 2021, the revenue gap for government effectiveness, which measures the quality of government policy and service provision, was 4.8 percentage points of GDP below what would be expected based on its peer group. Tax revenue was 4.6 percentage points of GDP below what its perceived level of control of corruption would predict, even though Guatemala has some of the worst corruption indicators in its peer group. Finally, in terms of the rule of law, which measures confidence in the legal system, Guatemala’s tax revenue underperformed expectations by 5.3 percentage points of GDP. Figure 9. Tax revenue (% of GDP) and per capita Figure 10. Tax revenue (% of GDP) and indicators GDP (current US$), Guatemala and peers, 2022 of government effec veness, Guatemala and peers, 2022 30 35% 1.5 35% (Current US$ 1,000) GDP per capita 25 30% 30% 1.0 Tax Revenues (% of GDP Government Effectiveness Tax Revenues (% of GDP) 25% 25% 20 0.5 20% 20% 15 15% 0.0 15% 10 10% -0.5 10% 5 5% -1.0 5% 0 0% -1.5 0% Source: OECD/IDB/CIAT Global Revenue Sta s cs and WDI Source: OECD/IDB/CIAT Global Revenue Sta s cs and WDI 21. When all tax drivers are taken together, Guatemala has a sizeable positive tax gap. Between 1991 and 2012, the tax gap was estimated at 51 percent (Fenochietto & Pessino, 2013), but between 1994 and 2009 it was estimated at 26 percent (Le, Moreno-Dodson, & Bayraktar, 2012). Recent estimates conducted for this PFR using a similar methodology show a tax gap around 30 percent for the period from 1980 to 2020.31 These estimates were performed for central government tax revenue only, 31 The tax gap is the difference between the actual tax revenue and the potential tax revenue, which is estimated through cross- country regressions over time (pool dataset) where the actual tax revenue is regressed on structural variables identified in the literature review above such as GDP per capita, trade, share of agriculture and institutional variables such as rule of law and control of corruption. 24 which excludes social security and municipal taxes. They indicate that central government revenue could rise from 12 of GDP to as much as 15 percent. D. Tax Revenue and Tax Policy Benchmarking 22. Guatemala’s tax burden is significantly below the CADR average and the averages both for aspirational and structural peers. Guatemala’s tax revenue in 2022 was 14.4 percent of GDP, the third lowest in the CADR region behind Panama at 13.1 percent and DR at 13.9 percent. Moreover, Panama received 3.3 percent of GDP in non-tax revenues, mainly from the Panama Canal, making Guatemala effectively the country with the second lowest revenue share in the region, far below the averages for the CADR (19.8 percent of GDP), structural peers (21.7 percent), and aspirational peers (24.8 percent). Guatemala’s revenue challenges are longstanding. Between 2013 and 2022, its tax revenue averaged 13.3 percent of GDP, significantly below the averages for CADR countries (18.6 percent), structural peers (20.5 percent), and aspirational peers (23.9 percent). 23. Guatemala’s tax structure relies more on VAT and less on PIT than those of its peers. PIT revenue accounted for only 3.7 percent of tax revenue in 2022, versus averages of 8.2 and 18 percent for structural and aspirational peers, respectively. This pattern also holds when looking at long-term averages and comparing them with individual countries in the peer groups. VAT revenue accounted for 41 percent of Guatemala’s tax revenue, compared to 31.5 and 29.2 percent among structural and regional peers. Among CADR countries, Guatemala is the most reliant on VAT followed by El Salvador (39.6 percent of total revenue). 24. Guatemala has an opportunity to increase income tax32 revenue, especially PIT, which would also improve the tax system’s progressivity. Between 2013 and 2022, Guatemala collected 0.46 percent of GDP in PIT on average, while structural and aspirational peers collected 1.58 and 3.71 percent. 33 While Guatemala’s PIT revenue has increased over time, staying at 0.53 percent of GDP in 2022, it remains well below the levels of structural and aspirational peers at 1.79 and 4.46 percent of GDP. The small share of PIT revenue reduces the redistributive capacity of the tax system. 25. Guatemala’s PIT rates are much lower than those of any peer country, and it has fewer tax brackets. Guatemala taxes income up to GTQ 360,000 (926 percent of GDP per capita) at a rate of 5 percent, while income above that level is subject to a rate of 7 percent. Incomes up to GTQ 48,000 (154 percent of GDP per capita) are not taxed. By comparison, El Salvador and the Dominican Republic each have four brackets, Costa Rica has five, and Chile has eight. Marginal PIT rates are also higher in peer countries. Among structural peers, the lowest marginal rate is 10 percent in Paraguay and the highest is 43 percent in Senegal. Among aspirational peers, the lowest marginal rate is 25 percent in Panama and the highest is 40 percent in Chile. 32 Guatemala imposes income tax on a territorial basis. 33 Guatemala does not have any income tax unallocable between corporate and personal income tax. 25 Figure 11. Tax revenue, Guatemala and peers, Figure 12. Tax structure, Guatemala and peers, 2013-22 average and 2022 (% of GDP) 2022 (% of total) 30 35 24.8 30 25 23.9 21.7 25 19.8 20.5 20 18.6 20 15 14.4 15 13.3 10 10 5 0 5 -5 0 2022 Avg 2013-22 Income Taxes Social Security Contributions Guatemala Structural Peers Aspirational Peers CADR Average Property Taxes Value-Added Taxes Other taxes on G&S Other Taxes Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: OECD/IDB/CIAT Global Revenue Sta s cs Figure 13. PIT revenue, Guatemala and peers, Figure 14. Top PIT rate, Guatemala and peers, 2013-22 average and 2022 (% of GDP) 2010-23 (%) 5 4.5 35 4 3.7 30 25 20 3 15 10 2 1.8 1.6 5 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 1 0.5 0.5 0 Guatemala Structural Peers Aspirational Peers 2022 Avg 2013-22 Guatemala Structural Peers Aspirational Peers Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: KPMG; IMF/FAD Tax Rate Database Figure 15. Marginal PIT rate, Guatemala, El Figure 16. Effec ve PIT rate, Guatemala, El Salvador, and Chile (% of 2021 GDP per capita) Salvador, and Chile (% of 2021 GDP per capita) Source: IBFD, CIAT, WDI, and WB staff calcula on Source: IBFD, CIAT, WDI. and WB staff calcula on 26. Guatemala’s low PIT rates and generous deductions result in low progressivity. Guatemala’s PIT rules allow for deductions for social security contributions, a personal allowance equivalent to 154 percent of GDP per capita, mid- and end-year salary bonuses, and donations. No deductions are allowed for medical or education expenses. Deductions are capped at a fixed amount but are available to all taxpayers regardless of income level. El Salvador’s tax system has similar provisions, but it allows 26 personal-allowance deductions only to lower-income taxpayers and limits the end-year bonus salary deduction to 33 percent of GDP per capita, which makes its PIT more progressive than Guatemala’s. Chile has simplified its PIT structure, and apart from social security contributions deductions, all other deduction are small and limited to lower income taxpayers. When rates and deductions are combined, Guatemala’s PIT is far less progressive than those of its peers. The effective zero threshold (i.e., the level of income at which individuals start to pay income taxes after the zero-rate bracket and/or universal deductions) is set at 154 percent of GDP per capita, versus 216 and 112 percent in El Salvador and Chile, respectively. Meanwhile, taxpayers with incomes over 1,000 percent of GDP per capita pay an effective PIT rate of 3.4 percent in Guatemala, compared to 18.1 and 13 percent in El Salvador and Chile. Table 3. PIT deduc ons, Guatemala, El Salvador, and Chile Deductions Guatemala El Salvador Chile Social Security Full. 4.83% of gross Full. 17% of gross salary Full. 10.25% of gross salary salary + fees Personal Allowances Yes. US$1,800 (39.6% of per Yes. $6,143 for capita GDP) for gross income No. individuals below 198% of per capita GDP Aguinaldo and Bonus Yes. 14.3% of gross Yes. Up to US$1,500 (33% of per No. salary capita GDP) Donations Yes. 5% of gross Yes, 5% of taxable No. salary. income up to $695,000. Medical and Education No (health), $178 Yes. Up to US$1,600 (35.1% of No. (education) for taxable per capita GDP) incomes up to $31,947 Memo: Effective zero threshold is 154% 216% 112% set at (% of GDP pc) Gini 48.3 39.0 44.9 Informality (% of GDP) 49.8% 42.8% 18.7% Source: IBFD, CIAT, World Bank. Table 4. Income (withholding) tax rates, Guatemala and peer countries Interest Dividend Royalties Capital Gains Guatemala 10% 5% 15% 10% El Salvador 10% 5% progressive tax rates 10% Honduras 10% 10% progressive tax rates 10% 2 Nicaragua 15% 3 15% 3 15% 15% 4 Paraguay 8%/ 15% 6 8%/ 15% 6 8%/ 15% 6 8% 7 Lithuania 15%/ 20% 8 15% 15%/ 20% 8 15%/ 20% 8 Chile progressive tax rates Panama 5% 5%/ 10%/ 20% 5 progressive tax rates 10% Source: IBFD, CIAT. 27 Notes: 1) Withholding taxes are final except for Chile, while Lithuania accepts some deduc ons. Most countries have some exemp on rules for some interest incomes and capital gains from sales of owner-occupied residencies. 2) If an asset has been held for less than 12 months, the progressive tax rates apply. 3) Applied to 70% of the gross amount, yielding an effec ve rate of 10.5%. 4) Applied to 80% of the gross amount, yielding an effec ve rate of 12%. 5) The lowest rate is applied on foreign-source income, the middle-rate applies to domes c-source income and the highest rate applies to bearer shares. 6) The lowest rate is for residents, while the highest is for non-residents. 7) Applied to 30% of the gross amount, yielding an effec ve rate of 2.4%. 8) The highest tax rate is applied for total income above €200k. 27. Guatemala’s withholding rates on capital income are equal to or higher than its tax rates on wages, which does not create a strong incentive for tax arbitrage. Guatemala has three different final withholding rates on non-salary income sources: 5 percent on dividends, 10 percent on interest and capital gains, and 15 percent on royalties. The use of different rates for different income sources is common across countries, although some countries, like Chile, have moved toward pooling all sources of income and applying a single progressive rate schedule34. Guatemala differs from its peers in that its withholding rates exceed the rates on wages, except for dividends. For example, El Salvador’s withholding rates on interest and capital gains are the same as Guatemala’s, but its marginal tax rate is much higher. As a result, high-net-worth individuals in Guatemala have less incentive to receive their income as capital income rather than wages. Guatemala also has few exemptions for capital income, with the most common being the exemption on capital gains from the sale of a personal residence. Figure 17. CIT revenue, Guatemala and peers, Figure 18. Top CIT rates, Guatemala and peers, 2013-22 average and 2022 (% of GDP): 2010-23 (%) 5 4.0 35 4 30 3.5 25 3.0 3 2.6 20 2.6 2.2 15 2 10 5 0 1 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 0 2022 Avg 2013-22 Guatemala Structural Peers Aspirational Peers Guatemala Structural Peers Aspirational Peers Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: KPMG; IMF/FAD Tax Rate Database Figure 19. Statutory and effec ve tax rates, Figure 20. CIT tax expenditures, Guatemala and Guatemala and peers (%) peers (% of GDP and % of CIT revenues) 34 There is currently a draft law in Costa Rica’s congress to move towards a unified rate schedule to all income sources. 28 Source: Bachas et al. (2023). Note: Guatemala (2006-2019), Source: Longino , Fernando. 2023. "Panorama de los gastos Honduras (2014-2019), Senegal (2010-2018), Albania (2015- tributarios en América La na". CIAT Documentos de Trabajo 1 2019), Costa Rica (2006-2019), and DR (2006-2015). Junio 2023 and IBFD. 28. Guatemala’s CIT revenue and effective CIT rate are lower than those of its structural peers, even though the nominal rate is the same as the structural peers’ average. Guatemala collects less CIT revenue (2.96 percent of GDP in 2022) than its structural peers (4.02 percent), but more than its aspirational peers35 (2.56 percent). This was true for 2022 and for the 10-year average. The nominal CIT rate in Guatemala (25 percent) is the same as the average of structural peers and above aspirational peers (21.8 percent). However, the effective CIT rate on profitable firms is 18.9 percent, which is 75.6 percent of the statutory rate, the second lowest share after Costa Rica among peer countries for which data are available (Bachas, Brockmeyer, Dom, & Semelet, 2023). 29. Guatemala’s low effective CIT rate reflects its high level of CIT tax expenditures. Guatemala’s CIT rules allow only for the usual deductions found in peer countries. CIT tax expenditures amount to 0.7 percent of GDP or 27 percent of CIT revenue. Guatemala’s CIT tax expenditures are above the structural peer average (14 percent of CIT revenue). However, this level of CIT tax expenditures is not unusual in the CADR region, with Guatemala being the median country. The largest CIT tax expenditures are not for maquilas36 and free-trade zones, which amount to 0.08 percent of GDP, but rather for universities and education (0.14 percent of GDP) and social security (0.15 percent of GDP). 30. Tax incentives for free-trade zones are common in the CADR region, and Guatemala’s are not the most generous. Guatemala offers three tax-incentive regimes for qualifying firms: a 10-year CIT exemption, a permanent VAT exemption, and select tariff exemptions. Honduras and El Salvador each grant a 10-year CIT exemption that can be extended or even become permanent. These two countries also grant full VAT and tariff exemptions. The introduction of pillar two of the Global Minimum Tax (GMT) agreement and its Global Anti-Base Erosion (GLoBE) rules may affect these tax incentives, since large multinationals might be required to pay an effective CIT rate of 15 percent (Box 1). Failing to review and update these incentives could cede revenue to other jurisdictions. 31. Guatemala has not benefitted from recent progress on international tax cooperation. Guatemala is not part of the inclusive framework for base erosion and profit shifting, but it ratified the Convention on Mutual Administrative Assistance in Tax Matters in 2017. The convention facilitates information exchange and is a valuable tool to fight offshore tax evasion, but amendments to domestic banking and tax laws that would allow access to information by the tax authority were suspended by the Constitutional Court. While this issue was resolved in 2019, Guatemala still does not participate in the automatic exchange of financial-account information with other jurisdictions, as the necessary primary and secondary legislation is still pending approval. Box 1: What is Pillar Two of the Global Minimum Tax Agreement? Broadly, pillar two is an agreement to ensure that large mul na onal enterprises pay an effec ve tax rate on corporate income of at least 15 percent in each country in which they operate. The rules are more complex than just applying a 15 percent tax rate across the board and involve the implementa on of the GLoBE rules. The main points of pillar two are as follows: 35 The aspirational peer group average is brought down by Panama and Latvia, which have low CIT revenues. 36 Maquilas are export-oriented manufacturers, often focused on product assembly. 29  GLoBE rules can be implemented through domestic legislation and do not require international tax treaties.  Pillar two applies to multinational enterprises with global revenues above €750 million in at least two out of the four previous fiscal years. Revenues from all firms in which the multinational have substantial control are consolidated in each country. Pension funds, controlled-asset holding companies, nonprofits, government entities (but not SOEs), and international organizations are excluded. There is a de minimis exclusion (revenues of less than €10 million and losses or profits of up to €1 million) to allow multinationals with small operations in certain jurisdictions to be excluded from the GLoBE rules.  The GMT’s tax base is the GLoBE income or loss, but it is only applied to multinationals if the jurisdictional effective tax rate is below 15 percent. This rate is calculated by dividing covered taxes by GLoBE income.  The GLoBE income or loss is the financial accounting of net income or loss adjusted for the following items: (i) net taxes expense, (ii) excluded dividends, (iii) excluded equity gains or losses, (iv) included revaluation methods for gains or losses, (v) gains or losses from the disposition of assets and liabilities, (vi) asymmetric foreign-currency gains or losses, (vii) policy-disallowed expenses, (viii) errors and changes in accounting principles, (ix) accrued pension expenses, and (x) international shipping income.  The covered taxes are the taxes paid by the multinational in the jurisdiction, which are covered by the GLoBE rules and include the following: (i) CIT, (ii) withholding taxes, (iii) taxes on distributed profits, and (iv) any tax imposed on lieu of a CIT. Covered taxes do not include taxes imposed by GLoBE rules.  If the effective tax rate is below 15 percent, a top-up tax (the difference between effective rate and the GMT rate of 15 percent) can be applied to profits within the GLoBE scope minus a substance-based carve out, which is a deduction equal to 10 percent of the payroll and 8 percent of the value of the tangible assets of the subsidiary in the jurisdiction. The carve out will be gradually reduced to 5 percent.  The application of the top-up tax follows the three rules below (the GLoBE rules) o The Income Inclusion Rule allows profits earned abroad by multinationals to be taxed in their home country if they are taxed below 15 percent in any other jurisdiction. o The Qualified Domestic Minimum Top-up Tax is imposed by the country in which a multinational subsidiary operates to tax excess profits locally, avoiding that these profits are taxed by the home country through either the Income Inclusion Rule or the Undertaxed Profits Rule. o The Undertaxed Profits Rule is a backstop to the Income Inclusion Rule. If the top-up tax has not been fully collected after the Income Inclusion Rule and the Qualified Domestic Minimum Top-up Tax have been applied, the parent company’s home country can increase taxation on the multinational by denying a deduction for otherwise-deductible expenses.  The Subject-to-Tax Rule (STTR) is within the scope of pillar two but is not a GLoBE rule. Rather, it is a provision to be introduced in tax treaties that will allow jurisdictions to impose a top-up withholding tax on interest, royalties, and other payments between related parties (e.g., subsidiaries within the same multinational group) when they are taxed at a nominal rate below 9 percent. 32. Guatemala’s small and medium enterprise (SME) tax regime37 is broad in scope but simple in structure, with a low revenue threshold compared to peers. The establishment of a beneficial SME tax regime is a common tax expenditure that can prove onerous and may distort incentives. All CADR countries except El Salvador have such a regime. Guatemala’s SME tax regime covers VAT, CIT, and the solidarity tax, with a single rate of 5 percent of gross sales. Any firm in any sector is eligible if its 37Although the regime is aimed at SMEs, it also allows individuals to opt for that regime. Similarly, there are SMEs that choose to pay their taxes within the general VAT regime. 30 annual revenue is below US$19.500, the second lowest threshold after Honduras. Guatemala’s SME tax regime has several positive aspects: it replaces several taxes with a single tax at a single rate subject to a single eligibility requirement. While its application to all sectors could lead to PIT evasion, the low PIT rates and SME threshold mitigate this risk in practice. 33. Social security contribution rates and revenues38 are lower in Guatemala than in structural and aspirational peers. Guatemala collected an average of 2.13 percent of GDP in social security contributions between 2013 and 2022, while structural and aspirational peers collected 3.5 and 6.75 percent of GDP, respectively. The share of the labor force that contributed to a retirement pension scheme was 20.3 percent in Guatemala, versus 16 and 60.4 percent in structural and aspirational peers. The combined employer and employee contribution rate in Guatemala is 17.5 percent of the worker’s wage,39 lower than in structural peers (21.6 percent) and aspirational peers (24.7 percent). However, an analysis of revenue gaps and policy options for social security contributions is outside the scope of this PFR. 34. Guatemala’s property tax base is underutilized. Property taxes include recurrent taxes on immovable property, sometimes known as real estate tax, but also taxes on net wealth, estates, inheritances, and gifts. Between 2013 and 2022, Guatemala collected an average of just 0.22 percent of GDP in property taxes, while structural and aspirational peers collect 0.32 and 0.67 percent, respectively. However, when looking only at recurrent taxes on immovable property, Guatemala collected 0.13 percent of GDP on average from 2013-2022, above the level of structural peers (0.09 percent of GDP) but still below the level of aspirational peers (0.52 percent of GDP). Figure 21. Property tax revenue, Guatemala and Figure 22. Real estate tax rate, Guatemala and peers, 2013-22 average and 2022 (% of GDP) peers (%) 1 2.5 2 2.0 0.7 0.7 1.5 1.47 1.5 1 1 1.0 0.9 0.3 0.7 0.3 0.6 0.2 0.5 0.35 0.2 0 0.0 0 2022 Avg 2013-22 Guatemala Structural Peers Aspirational Peers Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: KPMG, CIAT; and IMF/FAD Tax Rate Database 35. Guatemala’s tax rates on immovable property are not low, indicating that most gains should come from updating the property cadaster. Immovable property is taxed by the municipalities at progressive rates of 0.2, 0.6, and 0.9 percent of the cadastral property value. These rates are in the middle of the range for peer countries, which vary widely from 0.05 percent in Albania to 2 percent in Lithuania. A cadaster for all 338 municipalities is kept by the Ministry of Public Finance, which is also responsible for collecting the tax in 57 municipalities. The central government imposes a specific 38 In line with the OECD/IADB/CIAT classification of income statistics, mandatory social security contributions paid to the government are treated as tax revenue. 39 This includes a one percent contribution for vocational training institutes and one percent contribution for the workers’ recreational facilities institute. 31 tax on inheritances, with rates ranging from 1 to 6 percent of the inheritance value for spouses and direct descendants to as much as 25 percent for non-related recipients. However, inheritances are not subject to PIT, while gifts and donations between living people are subject to VAT. 36. Although the potential revenue gains might not be large in the short term, property taxation has unique advantages. Property taxes are efficient because they apply to highly visible and immovable assets. They are also an equitable and less distortionary way to fund local services, and if applied to market value they may incentivize a more efficient use of land. Property taxes can also encourage greater efficiency and accountability among local governments. Property taxes tend to be especially progressive, as the burden is largely borne by capital owners, which are normally wealthier households, and the tax code can provide exemptions or reduced rates for poor or vulnerable households, such as those headed by elderly people.40 37. Consumption is already the largest tax base, but it still offers opportunities for further mobilization. The two main consumption taxes are VAT and excise tax. Between 2013 and 2022, Guatemala collected an average of 6.85 percent of GDP in consumption taxes, while its structural and aspirational peers collected 10.49 and 10.08 percent of GDP, respectively. Although revenue from consumption taxes rose to 7.6 percent of GDP in 2022, it remains below the levels of structural and aspirational peers (10.82 and 10.02 percent of GDP, respectively). 38. There is scope to increase VAT revenue by raising rates, broadening the tax base, and strengthening compliance. Guatemala collected an average of 5.14 percent of GDP in VAT revenue from 2013 to 2022, while structural, aspirational, and CADR peers collected 6.61, 6.71, and 5.29 percent of GDP, respectively. Guatemala’s VAT revenue remained below peer-group averages in 2022. 39. Guatemala’s low VAT relative to its peers helps explain the gap in consumption tax revenue. Guatemala’s VAT rate is 12 percent, while the averages for structural and aspirational peers are 14 and 17 percent, respectively. Among structural peers, only Paraguay has a lower VAT rate (10 percent), while among aspirational peers only Panama has a lower rate (7 percent). Panama is also the only CADR country with a lower VAT rate than Guatemala. Figure 23. Average VAT revenues, Guatemala Figure 24. VAT rates, Guatemala and peer groups, and peer groups, 2013-22 (% of GDP) 2010-2023 (%) 8 18 7.2 6.8 6.7 17 7 6.6 5.9 16 6 5.1 15 5 14 4 13 3 12 2 11 10 1 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 0 2022 Avg 2013-22 Guatemala Structural Peers Aspirational Peers Guatemala Structural Peers Aspirational Peers Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: KPMG, CIAT; and IMF/FAD Tax Rate Database 40The 2018 population and housing census show that 80 percent of the housing units were owned by their occupants, however, most of these houses don’t have access to basic services or lack basic structures. For example, only 42 percent of the housing units have trash collection and almost 30 percent don’t have an exclusive room for kitchen in the house. 32 Figure 25. VAT tax expenditures, Guatemala and Figure 26. VAT rates, Guatemala and CADR peers, (% of GDP and % of VAT revenues) countries (%) Source: OECD/IDB/CIAT Global Revenue Sta s cs, Global Tax Source: IBFD and CIAT expenditure database, and CIAT. 40. Noncompliance is the main challenge in VAT administration. Guatemala has a c-efficiency ratio of 0.52 (average 2019-21), meaning that it collects only half of its potential VAT revenue, with noncompliance responsible for 65 percent of this gap (or 31 percent of potential tax revenue), while tax expenditures account for the rest.41 The Superintendent for Tax Administration (Superitendencia de Administración Tributária, SAT) produces annually its own estimates of the compliance gap using a similar methodology but with more details and exclusions, which yields an estimated gap of 28.5 percent of potential VAT revenue for the period but a lower estimate of 24.8 percent for 2023— indicating that compliance has recently improved. Although lost revenue due to noncompliance exceeded the cost of tax expenditures in 2019-21, VAT tax expenditures are large. In 2023, they accounted for 1.4 percent of GDP and 24 percent of VAT revenue, according to SAT’s annual estimates. 41. Guatemala’s excise tax revenues are below the levels of its peers. Guatemala collected 1.01 percent of GDP in excise taxes on average from 2013 to 2022, while structural, aspirational, and CADR peers collected 1.92, 2.12, and 1.94 percent of GDP, respectively. Guatemala’s 2022 excise tax revenue (0.97 percent of GDP, was also below all peer-group averages. Guatemala applies excise taxes to five types of goods: (i) fuels, (ii) cement, (iii) tobacco, (iv) alcoholic beverages, and (v) nonalcoholic beverages. 42. Excise rates in Guatemala are relatively low and have not been revised for a long time. Excise taxes are a mix of ad valorem rates applied to the value of tobacco and alcoholic beverages and specific taxes applied to each unit of nonalcoholic beverages, fuels, and cement. Countries use different mixes of ad valorem and specific taxes, which makes comparisons difficult, but Guatemala’s excise rates are clearly lower than those of its peers. Guatemala’s fuel tax is set at US$0.16 per liter, the same value as Panama. El Salvador has a lower specific rate, but it is complemented by an ad valorem tax that increases when oil prices are low. Guatemala taxes beer at a rate of 6 percent, the lowest rate among countries with ad valorem or combined taxes. In addition, specific rates have not been adjusted since the excise tax was established, while most countries have adjusted their rates since 2003. 41(Longinotti, 2024) calculated the VAT’s C-efficiency for all CADR countries and decompose it between the policy gap (tax expenditures) and the non-compliance gap. The decomposition is done by subtracting the tax expenditure amount from the total non-compliance amount. The VAT Revenue Ratio or C-efficiency is a number from 0 to 1 that compares the actual VAT revenue with the revenue that would be obtained if the tax were perfectly applied at a uniform rate, equal to the standard rate, on all consumption. 33 43. Guatemala also has considerable scope to leverage environment-related tax bases, including carbon emissions. Taxes (and subsidies) can help countries decarbonize and fund climate adaptation and mitigation efforts. In Guatemala environment-related taxes42 generated just 0.82 percent of GDP in revenue in 2021, well below the OECD and CADR averages of 1.96 and 1.31, respectively, and in line with the LAC average of 0.82 percent. Guatemala’s net effective carbon rate, which combines all levies on fuels, as well as specific carbon-pricing and emissions-trading mechanisms, minus subsidies, is also near the bottom for peer countries. Its net effective carbon rate is €9.87 per ton of carbon dioxide equivalent (tCO2e), the lowest among CADR countries for which data are available and far below the levels of aspirational peers (€37.23/tCO2e), the world average (€37.23), and the OECD average (€62.21). In addition, tax rates vary widely among fuels, with the highest rate on gasoline (€58.35/tCO2e) and rates of zero on fuel oil and coal. Table 5. Excise tax rates on selected products, Guatemala and peers Cigarette (per Beer (per Distilled (per Soft Drinks Gasoline (per Last 1,000) liter) liter) (per liter) liter) adjustment Honduras $23.54 $0.28 $1.88 $0.04 $0.22 annual Nicaragua $104.44 15% + $1.62 37% + $1.62 15% $0.23 annual Chile 30% + $78.3 20.50% 31.50% 18% $0.46 monthly Guatemala 100% 6% 8.5% $0.02 $0.16 2003 El Salvador 39% + 22.5 8% + $0.09 8% + $0.16 10% $0.12 + 0% to 1% 2010 Panama 100% $0.23 $0.90 7% $0.16 2015 Source: IBFD and CIAT. Note: Specific taxes reflect the amount and exchange rates as of January 2025. Figure 27. Excise tax revenues Guatemala and Figure 28. Environment-related tax revenues (% of peers, 2013-2022 average (% of GDP) GDP) and net effec ve carbon rate (€/tCO2e), Guatemala and peers 3 1.0% 35 30 0.8% 2.1 1.9 25 2 1.8 1.7 0.6% 20 1.0 0.4% 15 1.0 1 10 0.2% 5 0 0.0% 0 2022 Avg 2013-22 Paraguay Guatemala Panama Chile Guatemala Structural Peers Aspirational Peers Environmentally Related Tax Revenues (% of GDP) Net Effective Carbon Rate (USD/tCO2) Source: OECD/IDB/CIAT Global Revenue Sta s cs Source: OECD (2022), Pricing Greenhouse Gas Emissions: Turning Climate Targets into Climate Ac on. 42An environmentally related tax is a tax whose base is a physical unit (or a proxy of a physical unit) of something that has a proven, specific negative impact on the environment regardless of whether the tax is intended to change behaviors or is levied for another purpose (OECD, 2005). 34 E. Tax Administra on Benchmarking 44. Responsibilities for tax administration are divided among three government agencies and between the central and subnational levels, but the SAT is the primary agency. While the Ministry of Public Finance is responsible for tax policy, authority over tax administration is shared by the SAT, the Guatemalan Social Security Administration (Instituto Guatemalteco de Seguridad Social, IGSS), the Office for Cadaster and Evaluation of Immovable Property (Dirección de Cadastro y Avaluo de Bienes Imuebles, DICAB), and the municipal governments. DICABI is responsible for collecting property taxes on behalf of municipalities that lack such capacity, while the IGSS collects all social security contributions. All other taxes are collected by the SAT, which is an autonomous government agency with a board presided by the minister of finance and composed of two other members nominated by the president. Mining and oil royalties, which are not considered taxes, are collected by the Ministry of Mining and Energy (Ministerio de Minas y Energía). 45. Guatemala has the basic elements of sound tax administration in place, but it lacks important intermediate and advanced features. Guatemala has a dedicated large-taxpayer office (LTO), like all peers except Panama, and it has an administrative tax-dispute settlement mechanism. Guatemala withholds income tax at source from employers, but it does not pre-fill tax returns, and it does not have a high-net worth individual (HNWI) program. All taxpayers are required to use electronic tax invoices and fiscal compliance mechanisms since 2023, and PIT returns may be completed online. 46. Guatemala’s tax administration is relatively well-staffed and well-resourced, but its indicators are below the levels of aspirational peers. Guatemala has 17 tax agents43 per 100,000 inhabitants, more than El Salvador (15.8), Honduras (11.5), Paraguay (15.2), and Senegal (8.0), but fewer than aspirational peers like Chile (25.4) and Lithuania (89.9). The SAT’s operating expenditures are equal to 0.09 percent of GDP, which is in the middle of the distribution among peers, with the lowest expenditures in Senegal (0.02) and Panama (0.03) and the highest in Latvia (0.25). Figure 29. Tax agents per 100,000 people and Figure 30. Large taxpayers/tax agents and opera ng expenditures as a share of GDP, revenue administered by the LTO as a share of net Guatemala and peers, 2021 or latest available revenue, Guatemala and peers, 2021 or latest data available data Source: Interna onal Survey on Revenue Administra on Source: ISORA (ISORA) 43 Tax agents are all employees of the tax administration, including those employed in support activities. 35 Figure 31. On- me filling rate, Guatemala and Figure 32. PEFA scores for revenue management, peers, 2021 or latest available data (%) Guatemala, Costa Rica, and El Salvador Source: ISORA Source: PEFA 47. The LTO could strike a better balance between size and exclusive dedication. Guatemala has 2.1 taxpayers per agent in the LTO, which is responsible for 43 percent of total revenue. While Guatemala has the highest ratio of dedicated tax agents to large taxpayers, the LTO’s share in total revenue is the second lowest after Lithuania at 41 percent. 48. On-time filling rates for corporate taxpayers are low, but above structural peers. On-time filing rates for CIT (69 percent) and VAT (66 percent) are above the average for structural peers (62 percent for both tax types) but below the average for aspirational peers (73 percent for CIT and 84 percent for VAT). However, the on-time filing rate for PIT is 98 percent, the same level as Latvia and the highest among all peers. The use of electronic payments reached 100 percent in 2021. 49. Guatemala fares worse than its peers on the revenue dimensions of the Public Expenditure and Finance Accountability (PEFA) assessment. The PEFA’s revenue-related questions can be used to assess and benchmark tax administration. Questions 19.1 through 19.4 cover the provision of information to taxpayers, the establishment and communication of redress procedures, the presence of a comprehensive, structured, and systematic approach for managing compliance risk, the undertaking of audits and fraud investigations, and the monitoring and collection of arrears. Although Guatemala’s latest PEFA was carried out more than five years ago, the country met only the minimum criteria for risk management and audits and investigations, performing worse on these dimensions than all countries except El Salvador. F. Recommenda ons 50. This section presents recommendations for reforming tax policy and administration to address the gaps identified above and leverage Guatemala’s revenue potential. Guatemala can increase its tax revenue by 2-3 percentage points of GDP in the medium term, as it underperforms its peers on indicators of almost all tax-revenue drivers. In parallel, the authorities should pursue a strategy to improve governance and strengthen public institutions, which together with economic growth and trade openness will allow the country to expand its tax revenue in the long term. The tax policy and 36 administration benchmarking exercise has revealed important gaps, and this section will lay out recommendations44 for addressing them. 51. Guatemala needs to increase tax revenue, but this should be done equitably and without harming growth. Reform efforts should focus on taxes that are more efficient, such as VAT and property tax, while striving to improve the overall progressivity of the tax system and safeguard the welfare of poor and vulnerable households. As soon as new household survey data become available, the government should conduct an incidence analysis of taxes and expenditures following the Commitment to Equity methodology. Moreover, any tax reform program will need to be accompanied by an effective communication campaign to explain the rationale and benefits of the change. 52. Guatemala can increase PIT revenues and enhance the progressivity of PIT45 by adjusting tax rates and brackets, consolidating income sources, and reducing deductions. Guatemala’s last PIT reform was in 2012, when the higher of the two marginal rates was reduced from 31 to 7 percent. The reform reduced PIT revenue and diminished the progressivity of the tax system. Guatemala can address these challenges by: (i) increasing tax rates and brackets judiciously, (ii) consolidating all income sources— wages, dividends, rent, etc.—and applying a single progressive tax schedule; and (iii) reducing tax allowances, ideally allowing deductions only for mandatory social security contributions or at least capping the most regressive deductions. Consolidating all income sources in a single tax schedule will improve the simplicity and equity of the system while reducing incentives for arbitrage. Tax rates and thresholds should be informed by micro-level simulations based on new household survey data to maximize redistribution and close the revenue gap.46 Reducing tax allowances will further increase equity and progressivity, as these allowances disproportionately benefit wealthier individuals. 53. Complementing the PIT reforms, Guatemala should introduce tax-administration innovations, including a HNWI program. To strengthen compliance, the SAT must obtain in a recurrent manner more third-party data on different income sources (e.g., interest income from financial institutions, rental income from real estate agencies, etc.) and use this information to pre-fill income in PIT returns. Currently, the SAT can only obtain this data by order of a competent judge and on an individual basis. The access and recurrent use of third-party data by the SAT to improve oversight and facilitate compliance by taxpayers would require changes in Guatemalan law and case law. The SAT should create a dedicated unit for HNWI, with a focus on professional-services providers, business owners, and managers, who have greater incentives and opportunities to gain from tax arbitrage and evasion.47 The government should aim to close regulatory loopholes, such as exemptions on income received by trusts or holding companies, that could be used to reduce the effective PIT rate on HNWI. Because these individuals are more mobile and can own assets and receive income abroad, international tax cooperation must also be strengthened. 44 In addition to the recommendations on tax administration advanced in this report, the World Bank currently has a technical assistance project with the government of Guatemala that supports improvements in tax administration that can yield up to 0.9 percentage points of GDP in extra tax revenues. 45 Research has shown that “reforms of the PIT lower the disposable Gini and increase the bottom income share and the smaller the government spending envelope and the smaller the tax system, the larger the beneficial impact of tax reforms on inequality” (Gupta & Jalles, 2022). 46 An Earned Income Tax Credit, which serves a cash transfer to low-income workers, is a good idea to consider since it reduces the disincentive to work and depending on the design can encourage female-labor force participation (Ormaechea, Pienknagura, & Pizzinelli, 2022). 47 For an in-depth guidance on establishing a HNWI program, please see (Buchanan & McLaughlin, 2017). 37 54. Guatemala can increase its CIT revenue by revising its tax expenditures. Guatemala’s lower effective CIT rate than peer countries highlights the importance of reducing tax expenditures. Tax-expenditure estimates are broadly consistent with international standards, but an external review could be commissioned to assess some methodological choices, like not treating the SME tax regime as a tax expenditure. Although Guatemala has estimated tax expenditures since 2001, those expenditures have not been reviewed or revised. The government could start by establishing a commitment (preferably in law) to evaluate all tax expenditures within a set timeframe48 and mandate that they be reauthorized after a certain period or after an evaluation. Tax expenditures should be subjected to a cost-benefit analysis that includes forgone revenue, distributional impacts, and the cost of administration and compliance.49 The result of the analysis should be presented as part of the medium-term budget framework. In addition, any new tax expenditure should be required to have a clear rationale. 55. Tax expenditures must be assessed to determine their compatibility with the GLoBE rules. Guatemala’s free-trade zones grant a 10-year CIT exemption that will be affected by the GLoBE rules, reducing the benefits for multinationals located in Guatemala. Moreover, the extra income tax paid by these multinationals may be remitted to countries other than Guatemala. Proactively reviewing CIT tax expenditures could reveal opportunities to replace them with incentives linked to investments in fixed assets or payroll expenditures. 56. CIT revenues can also be increased through better enforcement. The SAT has the largest dedicated LTO program among its peers and should bring more companies under its mandate. If the number of large taxpayers per staff member were increased from 2.1 to 3, the SAT would be able to bring 259 new taxpayers under the LTO’s authority while retaining the largest staff-to-taxpayer ratio among peer countries. Similarly, for PIT taxpayers automatic data exchange, international cooperation, and cross-checks are key to inform enforcement efforts and reduce tax evasion. 57. Special tax regimes like SME taxation are normally created to deal with informality but can introduce their own problems and create arbitrage opportunities for taxpayers. Special tax regimes in which firms pay a lower tax rate if their revenues are below a given threshold can create challenges such as “bunching” (Bettendorf, Lejour, & van 't Riet, 2017), under-reporting of profits either through inflated costs or reduced revenues (Garriga & Scot, 2023) and (Bachas & Soto, 2021), and resource misallocation (Bachas, Jaef, & Jensen, 2019). Moreover, many firms are informal not just because of taxation but also due to other constraints on entering and remaining in the formal sector (Ulyssea, Bobba, & Gadenne, Informality, 2023). To deal with informality effectively, policymakers must understand all relevant constraints and design a holistic response. Informal firms can be divided into three groups (Ulyssea, 2018). The first group consists of firms that could pay taxes but do not pay due to information and access barriers. For these firms, the best policy approach is to make information easily accessible (e.g., by using simple terms, presenting materials in different languages, and disseminating information through multiple channels). The second group is formed by firms that have very narrow margins and would not be commercially viable if they paid taxes at standard rates. These firms can benefit from a lower tax burden and minimal compliance requirements but may also require 48 For example, Germany requires all tax expenditures to be evaluated in a 10-year cycle, while the Netherlands does in a four to seven-year cycle. 49 Analytical techniques can range from simple static comparison analysis to complex randomized control trials. For more detailed information on analyzing tax expenditures, see (Beer, Benedek, Erard, & Loeprick, 2022) and (Redonda, von Haldenwang, & Berg, 2023). 38 technical assistance with filing and payment. In a recent study, SMEs that receive registration assistance and participated in a bank information session increased their sales and profits by 20 and 15 percent, respectively (Campos, Goldstein, & McKenzie, 2023). Firms in the third group pay little or no taxes as a business strategy. The best policy for this group is increased enforcement. Box 2. Good prac ces for SME tax regimes Although Guatemala’s SME tax regime is broadly sound, it could be improved based on the principles below:  Objectives should be threefold: (i) reduce compliance costs for taxpayers, (ii) reduce enforcement costs for the tax administration; and (iii) incentivize formalization rather than prioritizing revenue.  The government must calculate tax expenditures arising from the regime, especially if including social security contributions to ensure affordability of the policy.  Coverage should be as broad as possible while ensuring that all taxes related to economic activity (CIT, PIT, VAT, and social security contributions) form a single tax (monotributo).  Scope should match typical SME activities (e.g., retail, restaurants, etc.) and exclude unincorporated business (e.g., liberal professions and intellectual and artistic activities).  Parameters should include sales, purchases, or assets (which can encourage underreporting and bunching), number of employees (which can disincentivize labor formalization), and water or energy consumption.50  Taxes should be lump sum for microenterprises, with a low and simple rate structure for small and medium firms.  The authorities should use technology extensively (e-invoice, e-payments, pre-filled forms, online simplified accounting, and automated recordkeeping) to reduce costs to taxpayers, minimize underreporting, and facilitate enforcement.  Rebates should be linked to the use of e-invoicing.  The tax administration should be able to automatically cross-check databases (e.g., credit cards, bank records, etc.)  The tax administration structure should adjust to help SME taxpayers, possibly via a specialized unit.  The SME regime should facilitate migration to the standard tax system, and the entry point into the standard system should be simple, with only a moderate increase in rates.  Technical assistance should be provided to SMEs to increase their productivity, survival, and tax revenue in the long term. 58. Recurrent property taxation can lead to sustainable revenue increases in the medium term but requires better property identification and valuation. Although the gains from raising property tax revenue to the levels of aspirational peers are relatively low at 0.2-0.3 percentage points of GDP, these revenues are more stable than other tax bases and can provide a reliable source of financing for local services while promoting accountability. The largest gains would come from the improved identification and valuation of all properties, as well as tighter enforcement. Good practices51 call for using a geographic information system to identify properties and using real estate transaction data to inform property valuations. 50 Barreix & Gonzalez suggest imposing a me limit for the taxpayer to benefit from the regime and crea ng an ul mate beneficiary registry. 51 Extensive guidance on property taxation can be found in (Kelly, White, & Anand, 2020). 39 59. Consolidating tax-administration offices can improve enforcement and save resources. Guatemala has three offices at the central level in charge of administering taxes: the IGSS (for social security contributions), DICABI (for property taxes), and the SAT (for all other taxes). Consolidation could leverage economies of scale in tax administration, not only in terms of back-office functions and systems, but also enforcement and taxpayer services. For example, because payroll taxes— the social security contribution base —are deducted from CIT and correlated with revenues and profits, taxpayers would benefit from paying all their taxes in a single online system. Almost half of the tax offices included in the latest ISORA survey are responsible for real estate tax, and 28 percent are also responsible for social security contributions.52 60. There is scope to increase VAT revenue both from goods and services. Guatemala’s VAT is well designed, with a single rate and a broad base, but VAT tax expenditures accounted for 64.2 percent of all tax expenditures in 2022. Reform efforts should focus on increasing compliance, revising tax expenditures, and strengthening administration. However, to increase VAT revenues in the near term, a small increase in the rate could be considered, since Guatemala’s VAT rate (12 percent) is below the levels of all CADR countries except Panama. 61. Imposing VAT on digital services and imports of low-value goods by consumers should be a priority. The expansion of digital trade and the increased internet penetration have led to the development of a thriving but digital economy, but digital services are undertaxed because most buyers are individuals, not business, and therefore are not regular VAT taxpayers. Moreover, most providers are not physically present in the country and have not registered with the SAT. To increase the collection of VAT revenue from the digital economy, the government should: (i) adjust the legal framework to make it clear that VAT on digital trade is imposed in the place of the consumer’s usual residence, (ii) require that digital providers and platforms collect and remit the VAT on behalf of their clients; (iii) create simplified registration and payment mechanisms for non-resident digital providers; and (iv) use third-party tax withholding (e.g., by credit card companies) to backstop enforcement as needed.53 The Interamerican Development Bank estimates that Guatemala could generate US$127 million (0.13 percentage points of GDP) in additional revenue in 2024 by taxing digital services.54 62. VAT tax expenditures are large and concentrated. Three exemptions account for 80 percent of VAT tax expenditures: (i) transfers of goods through inheritances, capital apportionment, or company mergers, (ii) financial intermediation; and (iii) private education services. Many countries exempt financial intermediation from VAT due to the practical difficulty of calculating the value-added margin for financial services that is not paid through an explicit fee, such as lending and borrowing. The problem with exempting the financial sector is that it breaks the VAT credit chain, which might lead to credit accumulation among banks. Nevertheless, fee-based services can be subjected to normal VAT, and a dialogue on how best to tax the whole of the financial sector is ongoing. 55 While taxing private education services does not pose practical challenges, some countries choose to exempt them based on the social desirability of supporting more and better education. However, this exemption 52 The joint administration of taxes and social security contributions is more common in upper-middle and high-income countries. Barbados, Jamaica, and Suriname are example of LAC countries that administer property tax and social security contributions in addition to the main taxes. 53 Detailed and practical guidance can be found at (OECD/WBG/CIAT/IDB, 2021). 54 (Garcimartín, Roca, & Dias, 2021). 55 For more detail on the challenges to impose VAT on the financial sector and pros and cons of different country approaches, please see (Schenk & Zee, 2024). 40 tends to be regressive, since the wealthiest households are the most likely to purchase private education services. For that reason, countries such as Costa Rica have moved to impose VAT on private education, albeit at reduced rates. 63. Revenue from excise taxes could be increased by adjusting the values of specific taxes and modernizing the design of the policy. Excise taxes have been set at the same nominal value since they were created in 2003, and inflation has significantly eroded their real value. The authorities should adjust these values for inflation—which would almost triple the tax rate—and authorize the MFP to continue adjusting them for inflation on a regular basis. Adjusting the excise rates to reflect past inflation could yield 0.9 percentage points of GDP in additional revenue.56 The tax on alcoholic beverages should also be increased, as it is lower than those of peer countries, and the balance between specific, ad valorem, and hybrid taxes should be reconsidered.57 Finally, the design of excise taxes could be modernized to consider pollution, health effects, and carbon emissions, broadening its scope and reducing externalities. IV. Public Financial Management A. Overview 64. Public expenditures58 declined after 2014 and remained low until 2020, when they spiked due to the pandemic response, but by 2023 expenditures were still lower than they were over a decade ago. Total expenditures ticked down from 14.2 percent of GDP in 2014 to an average of 13.6 percent from 2014 to 2019. The COVID-19 crisis pushed expenditures to 15.5 percent of GDP in 2020, but in 2024 they declined to 13.7 percent of GDP, close to their 2013 level. Figure 33. Public expenditures as a share of GDP Figure 34. Expenditures by func on, 2015- and in per capita terms (constant LCU), 2014- 2024 (% of GDP) 2024 16% 16.0% 6,800 14% 15.5% 6,600 12% 15.0% 10% 6,400 14.5% 8% 6,200 6% 14.0% 6,000 4% 13.5% 5,800 2% 13.0% 0% 5,600 12.5% 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 12.0% 5,400 Social Protection Education Economic Affairs Public Security 11.5% 5,200 Housing and community services Health 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Others Social Expenditures % of GDP Per Capita Source: MFP, BANGUAT, and WB Staff calcula on Source: MFP 56 This estimate does not consider indirect effects such as reduction in demand due to higher prices and positive benefits on health and productivity due to lower pollution and diminished sugar and alcohol intake. 57 Uniform specific rates reduce relative price differences between low-priced and high-priced brands, whereas uniform ad valorem rates increase absolute price differences. The choice between these two depends on whether the primary aim of tax policy is to discourage consumption or to raise revenue, and on whether improvements in product quality are deemed desirable or not. The imposition of a specific tax per unit makes it harder to evade taxes by under-reporting the price of goods. 58 All expenditures analysis is done at the central government level. 41 65. Public expenditures have increased in real terms, but per capita spending is not much higher than it was a decade ago. From 2014 to 2024, expenditures grew by 24.9 percent (or 2.3 percent per year59) in real terms but by just 7.2 percent (or 0.7 percent per year) in real per capita terms. The government spent LCU 6,547.3 per person in 2024, up slightly from LCU 6,108.9 in 2014. 66. The composition of public expenditures by economic category has changed slightly in the last decade, with current expenditures growing and public investments declining. The share of current expenditures in total spending increased from 93.3 percent in 2014 to 97.6 percent in 2024, stable around 13.4 percent of GDP. Interest payments increased from 1.4 percent of GDP in 2014 to 1.6 percent in 2024, while public investments declined from 1 to 0.3 percent of GDP. 67. The increase in current expenditures occurred mainly during the pandemic response and was focused on goods and services and transfers . Current expenditures accounted for about 13 percent of GDP from 2014 to 2019, spiked to 14.1 percent in 2020-21, then fell to 13.4 percent in 2024. Goods and services and transfers were entirely responsible for the increase in current expenditures. 68. The main expenditure by government function is education, while social protection and health rank fourth and fifth. Education expenditures—including current and capital spending—averaged 22.6 percent of total public spending and 3.1 percent of GDP from 2015 to 2024. The second largest expenditure category (excluding public debt transactions, interest, and amortization) was public order and citizen security, which accounted for 12.2 percent of total spending and 1.7 percent of GDP from 2015 to 2024. The next-largest expenditure categories were urbanization and community services (10.3 percent of total spending and 1.4 percent of GDP), social protection (9.9 percent of total spending and 1.4 percent of GDP), and health (9.2 percent of total spending and 1.3 percent of GDP). 69. Expenditures on education and citizen security have increased slightly over the last decade, but the composition of public spending has remained broadly stable. Between 2015 and 2024, expenditures on education remained stable around 3.1 percent of GDP (excluding public debt transactions). Meanwhile, spending on citizen security increased from 1.5 to 1.8 percent of GDP and from 11.6 to 13 percent of total public spending. Social public expenditures, a metric that has been tracked since the end of the civil war and that includes spending on education, health, social protection, environmental protection, disaster response, urbanization, and leisure increased from 7.3 percent of GDP (55.5 percent of total spending) in 2015 to 8.2 percent of GDP (59.8 percent of total spending) in 2024. 70. Most expenditures have been financed by own-source revenues, except during the pandemic response. The government’s own resources (Treasury revenues and those collected by decentralized agencies) financed 82.3 percent of the budget on average from 2015 to 2024. This average increases to 84.1 percent if the year 2020 is excluded, as the pandemic led the government to finance two- thirds of the budget through external sources (loans and grants) during that year. External sources funded 17.7 percent of the budget during 2015-2024, with grants accounting for just 0.2 percent of the budget. Domestic borrowing sources financed 10.2 percent of the budget, while external borrowing sources covered 7.3 percent. 71. Budget execution rates are normally high but were also affected by COVID-19. The central government’s budget-execution rate averaged 92.3 percent from 2015 to 2023. This average is dragged down by the years 2020 and 2021, when pandemic-related disruptions reduced the execution 59 CAGR = compound average growth rate. 42 rate to 88.1 percent. If these years are excluded, the rate climbs to 93.4 percent. Budget-execution rates are slightly lower among decentralized agencies—89.3 percent for the period—but their expenditures account for just 1 percent of central government spending. B. Performance-Based Budge ng 1. Introduc on 72. This chapter discusses GpR, the Guatemalan system of performance-based budgeting. GpR aims to achieve objectives similar to those of other performance-based budgeting systems around the world, including enhanced expenditure efficiency, effectiveness, and prioritization. The Guatemalan system consists of three core components:  Program budgeting: Under GpR, programs are used to prepare and approve the budget and to control expenditures during budget execution. Ministries present their budgets on a program basis, Congress approves the budget on a program basis, and ministries are required to respect the budgetary allocations to programs during execution60. Programs are viewed as vehicles for giving budgetary expression to the expenditure priorities established during the planning process.  Target setting: Targets are set for all performance indicators developed under GpR. Most targets are physical targets (metas físicas), which target a given output quantity. The physical targets are intended to promote efficiency by linking the volume of goods and services delivered with budgetary funding. In principle, the annual quantitative values of the physical targets are calibrated to the level of budget funding provided for each specific output. In addition to the physical targets, other targets are set out in strategic plans at the institutional, sectoral, and government-wide levels, which have a much looser relationship to the budget.61 These include a range of outcome targets intended to promote effectiveness.  Planning-based prioritization: GpR is designed to leverage budget planning as a basis for expenditure prioritization. The budget is prepared after the plans and designed to embody the prioritization decisions made during the planning stage. 73. GpR was implemented gradually across the government starting in 2013, building on a strong supporting infrastructure.62 Following a high-level government decision, implementation proceeded rapidly, with only a single pilot in the Ministry of Health having been carried out prior to the governmentwide rollout. By 2017, all central government agencies had implemented GpR, and by 2022 its coverage had been extended to all autonomous and decentralized agencies. Responsibility for the design and management of the system is shared between the MFP and the General Secretariat for Planning of the Presidency (SEGEPLAN). Within the MFP, the Technical Directorate of the Budget (Dirección Técnica del Presupuesto) has played the lead role. 74. Guatemala has done a particularly good job of establishing the supporting infrastructure for GpR. The Organic Budget Law (Ley Orgánico del Presupuesto, LOP) was extensively modified to provide a strong legal basis for GpR. The integrated financial information management system (Sistema 60 Only Congress can modify, approve or disapprove the draft budget. 61 These targets are set under a number of headings including metas estrategicos de desarrollo (MEDs), resultados estrategicos de desarrollo (REDs), resultados estrategicos and resultados institucionales. 62 Although the GpR’s conceptual guide was finalized in 2013, MINFIN had been implementing elements of results-based management in the budget since 2000. See the 2023 budget proposal, Section 7.1, subsection 1.2, for further details. 43 Integrado de Administración Financiera, SIAF) was redesigned to fully incorporate financial and non- financial budget preparation, accounting, and reporting in the manner required for GpR. The high- quality work undertaken to ensure that SIAF supports GpR is consistent with Guatemala’s reputation as a regional leader in digital public financial management technology. Substantial training and broader capacity-building efforts have also been undertaken since GpR was introduced. Box 3. Performance Terminology in GpR Outcomes (resultados) are changes that government interven ons bring about in individuals, social structures, or the physical environment. For example, literacy is an educa onal outcome; increased crop yields are an outcome of agricultural programs; reduced death and disability are outcomes of health services; and reduced crime is an outcome of policing. Outputs (productos) are services delivered to, or for the benefit of, the public. Outputs are necessary to achieve outcomes. Examples of outputs include medical treatment; advice provided to farmers by agricultural extension officers; students taught in public schools; and criminal inves ga ons by the police. In prac ce, most outputs delivered by government are services, but goods may be outputs as well. The term output is also used to cover benefits and subsidies paid by the government to ci zens and the private sector, such as social welfare benefits. Ac vi es (ac vidades) are the work processes used to produce outputs. For example, ac vi es that contribute to the delivery of medical services include surgery, nursing, hospital cleaning, medical recordkeeping, and the dispensing of pharmaceu cals. Other examples of ac vi es include staff recruitment and public consulta ons on proposed new public policies or plans. Inputs (insumos) are the labor, material, equipment, buildings and other resources that are used in ac vi es that produce outputs. Resources used to pay for government services are considered an input. Physical targets (metas sicas) are performance targets typically pertaining to the quan ty of outputs delivered, although in prac ce some metas sicas do not relate to outputs. Effec veness refers to the extent to which an output achieves its intended outcome. Educa on is effec ve if students learn. Policing is successful if it reduces crime. Agricultural advice is effec ve if it improves produc vity. Efficiency refers to the delivery of outputs without wasteful and unnecessary costs. The lower the cost at which a service is delivered, the more efficient its produc on. This is what is some mes referred to in economic terminology as "technical" or "produc ve" efficiency. Expenditure priori za on means alloca ng limited government resources to the mix of outputs that yields the greatest benefit to society. This is what economists refer to as “alloca ve efficiency”. 75. GpR is one component of a broader set of budgeting and public financial management reforms implemented in Guatemala over the past decade or more. Other measures include extensive and multifaceted improvements to the financial management information system; efforts to broaden the coverage of the Treasury Single Account; reforms to procurement systems; improvements to the monitoring system for public investment projects; and a range of measures to enhance fiscal transparency, including the establishment of an open data portal. The legal framework has been modified extensively to support these reforms, both through new legislation (e.g., on fiscal transparency) and major amendments to various existing laws and regulations. 2. The Budge ng Context 76. Three aspects of Guatemala’s public finances influence GpR: low public expenditure levels, limited discretionary resources, and financial uncertainty during budget execution. 44  Due to limited government revenue, public spending is low by international standards. The 2021 general government budget (excluding interest payments) stood at 13 percent of GDP, one of the lowest levels in Latin America and in the developing world.63 Low expenditure levels sharply limit public service delivery regardless of the efficiency and effectiveness of public spending.  Discretionary resources—i.e., the fiscal space available for new spending64—are particularly limited because most budgetary financing goes to rigid expenditure commitments.  Ministries face significant financial uncertainty during budget execution because they frequently receive less than the amount appropriated in the budget law.65 The resources released to ministries are determined during the fiscal year based on government revenues, which are often overestimated in the budget.66 3. Program Budge ng 77. Guatemala’s budget-classification system uses a four-level program hierarchy . The top two levels are programs and subprograms. For current expenditures, the third and fourth levels are activities (also known as products) and subproducts. For investment expenditures, the third and fourth levels are projects and works. 78. Guatemala’s use of program-based budgeting is more advanced than in most developing countries, as it forms the real basis for budget allocations and is not for informational purposes only. Guatemala’s budget is approved and executed on a program basis, whereas many other developing countries have sought to introduce program-based budgeting but have only developed an “indicative” program budget that lacks legal force. 79. Although certain aspects of the program structure could be improved, GpR is consistent with internationally accepted program-based budgeting principles in the following key respects :  Programs mainly represent groups of outputs with shared outcomes. The Ministry of Health, for example, has programs covering preventive health interventions, medical treatments, maternal and neonatal health, and other areas of service delivery.  An administration program within each ministry covers internal support services.  Programs include capital as well as current expenditures.  There is considerable input flexibility during the execution of the program budget. 80. Line ministries enjoy substantial input flexibility in the execution of budget programs. Although the budget is approved on a detailed line-item basis,67 ministries have discretion to shift money between line items subject only to the need to respect aggregate limits for several broad object categories, of 63 For comparative purposes, the figures for selected other Latin American countries are Honduras (22 percent); Peru (18 percent); Paraguay (17 percent); Mexico (20 percent) and Brazil (38 percent) (data sourced from IMF Government Finance Statistics database). For developed OECD countries, the corresponding figures are higher – for example, United States (39 percent); Australia (39 percent) and France (57 percent). 64 Baseline is all spending required by existing policies and commitments. New spending is defined as anything beyond this. 65 Guatemala PEFA (2018). 66 One of the reasons for revenue underestimation is that the renewal of the SAT’s superintendent contract, which must be renewed every year, is conditioned on the achievement of revenue targets. 67 Down to the renglones level of the object classification. 45 which personnel expenditure is the most important.68 This degree of input flexibility is broadly consistent with one of the fundamental principles of program-based budgeting (and performance budgeting more generally), which is the principle of managerial freedom to deliver results in the most efficient manner, with accountability for results rather than detailed input control. In this respect, Guatemala differs from many other developing countries in which the ministry of finance has been unwilling to relinquish input control as part of the shift to program-based budgeting. Transfers between programs are possible during budget execution, subject to appropriate approvals.69 4. Planning and Priori za on 81. Planning is a central element of the GpR system. Plans are developed at the governmentwide, sectoral, and institutional levels. Governmentwide plans include the ten-year National Development Plan (K’Atun) with targets for 2032 and the five-year General Policy of the Government (Politica General de Gobierno, PGG), The PGG is intended to guide budgetary resource allocation directly, and its current iteration covers the period from 2020 to 2024. Institutions develop five-year institutional strategic plans (planes estratégicos institutionales), on which multi-annual and annual operational plans (planes operativos multianuales y anuales) are based. The governmentwide, sectoral, and institutional plans are elaborate documents that contain detailed information on government objectives, strategies, and services. In this sense, the GpR planning mechanism is an impressive success. 82. The public sector’s main planning challenge is to prevent the process from becoming a rote or symbolic exercise. The international experience shows that expenditure planning can become a perfunctory paperwork exercise that has a limited impact on actual budgeting, policy, or management. Preventing this requires a strong planning model and a meaningful relationship between planning and budgeting. 83. In the GpR framework, prioritization takes place during planning and is then reflected in the budget. Under the GpR, prioritization decisions are made during the planning process and then incorporated into the budget. As defined in Article 8 of the Organic Budget Law, “public budgets are the annual expression of the state’s plans.”70 84. In this model, medium- and long-term targets for selected key outcomes are set forth in strategic plans at the government-wide, sectoral, and institutional levels. Institutional operational plans then specify the volumes of outputs required to achieve these outcome targets and the amount of money required to deliver the necessary outputs. After the planning process has been completed, the budget is prepared (Figure 35). 68 Although there is an arguably unnecessary requirement for the Ministry of Finance to be provided with the justification for each transfer between renglones. Legal provisions relating to transfers between items in the object classification of expenditure are in Article 32, LO. 69 In the case of a transfer from one program to another, the finance minister must approve the transfer. Transfers between sub-programs may be approved by the relevant minister (Article 32, LO). 70 “Los presupuestos públicos son la expresión anual de los planes del Estado .” 46 Figure 35. Planning and budge ng under the GpR 85. A key characteristic of planning-based prioritization is that it does not consider any prior government expenditure commitments. Thus, Planning is generally a blank-slate exercise in the sense that it implicitly assumes that government is deciding what needs to be done without considering the extent to which budgetary resources are already tied up in baseline expenditures such as legal and contractual commitments and the remuneration of the existing government workforce. As a result, the planning process is financially unconstrained, with headline targets, required output volumes, and necessary budget funding all estimated in the plans without regard to resource availability. Governmentwide planning is led by SEGEPLAN, while line ministries develop their own plans. 86. Because existing commitments are not considered, the funding needs estimated in the planning process often significantly exceed the availability of budget resources.71. The significant gap between the resource needs estimated in the planning process and the budget funding ultimately provided creates “profound discord” between planning and budgeting.72. This tends to limit the ability of the plans to guide the prioritization of resources in the budget. Therefore, the real prioritization of expenditures—i.e., what in the plan will be financed—is determined during budget preparation. 87. More advanced performance-based systems undertake resource-constrained prioritization and leave room for prioritization adjustments during budget preparation. A significant number of developing countries use the same model, in which prioritization takes place in the planning stage prior to budgeting. However, real prioritization occurs only when allocative decisions are made during the budget-preparation process. While plans prepared prior to budgeting can help inform the budget, they cannot be expected to provide a blueprint for the allocation of resources in the budget. 88. Medium-term budget frameworks (MTBF) aim to integrate planning and budgeting by applying different prioritization approaches to baseline and new spending. The MTBF aims to integrate planning and budgeting by first recognizing the distinction between baseline expenditures and new 71 This is true even though, as noted in the 2018 PEFA (92), the plans leave out a significant component of spending on the capital side. 72 Ministry of Communica ons, Infrastructure, and Housing, Plan Opera vo Anual 2023 y Mul anual 2023-27 (43-44), "las brechas existentes entre la planificación-presupuesto aprobado … denota una profunda discordancia entre dos procesos que deben ir enlazados si se habla de Ges ón por Resultados." 47 spending, then applying distinct prioritization processes to each. The prioritization of new spending involves making choices about the allocation of the available fiscal space. Prioritization that occurs within baseline spending involves separate processes, such as a “spending review,” to identify potential savings that could increase the available fiscal space. While new spending is prioritized from scratch, prioritizing baseline expenditures involves changing policies and laws, which in some cases may be quite difficult. For these reasons, baseline spending can often be changed only slowly and at the margin. 89. Guatemala currently does not have a MTBF. Although Guatemala now publishes a multiyear budget (presupuesto multianual), it does not incorporate the distinction between baseline and new spending and does not appear to have any significant role in the expenditure-prioritization process. For these reasons, it cannot yet be treated as an MTBF. 90. To fully achieve the GpR’s objective of integrating planning and budgeting, the government should consider:  Strengthening prioritization mechanisms that operate during (as opposed to before) budget preparation, especially assessments of new spending proposals and processes for identifying and achieving savings on baseline spending.  Building feedback from performance indicators into budget preparation by creating a performance-dialogue mechanism between the MFP and each ministry.  Distinguishing explicitly between baseline and new spending by developing medium-term baseline expenditure estimates as part of a strengthened medium-term budgeting process. 73 a) Complexity of Planning 91. The planning process under GpR is overly complex. Ministries and other institutions are required to apply a complex blueprint when developing their plans. Mandatory plans include numerous components, such as “conceptual models,” “explanatory models,” “prescriptive models,” “results chains,” and “logic models,” some of which are duplicative. Ministries are also required to apply many highly technical concepts to their plans, and the plan guidelines often use several different terms to refer to the same technical concept or closely related concepts. There is also considerable overlap between the content requirements of the different planning documents—e.g., between the institutional strategic plans and the multiyear operating plans. 92. As a result, plans are less useful than they could be. Institutional plans are long, complicated, and highly theoretical. They also suffer from conceptual confusion, which contributes to incomplete compliance with the plan guidelines. Although the guidelines specify that planning should be anchored to outcomes, many ministries’ plans focus almost entirely on outputs, activities, and inputs. Ministry plans often fail to include the required content of SWOT74 analysis. Some elements of the planning instructions, such as the mandated unit costing of outputs,75 are ignored in practice. 93. Planning could be more cost-effective, and of greater practical value, if the planning model were simplified. Shorter, more focused plans could more effectively serve as practical guidance documents. 73 Please see recommendation #2 in Table 1. 74 Strengths, Weaknesses, Opportunities and Threats 75 Estrategia de Programación del Proceso de Planificatión y Formulación del Presupuesto General de Ingresos y Egresos del Estado para el Ejercicio Fiscal 2023 y Multianual 2023-2027 DTP, SEGEPLAN, February 2022, p. 22. 48 Simplifying the planning model could also yield substantial savings in terms of the institutional resources required to prepare the plans. 5. Performance Indicators 94. Good performance indicators are fundamental to the success of any performance-based budgeting system. The adoption of GpR led Guatemala to considerable progress in the development of performance indicators, but there are opportunities for further improvements. Precise indicators of outcomes and output quality are especially relevant to the efficiency of GpR as a tool for expenditure prioritization. 95. GpR has many good output indicators, but very few output-quality, equity, or outcome indicators. Output quantities are the strongest aspect of performance reporting under the GpR. Numerous indicators of output quantity (“productos” and “subproductos”) are used to set the annual physical targets. These indicators include the number of students in bilingual schools, the number of people diagnosed and treated for hemorrhagic dengue, and the number of naval patrols. However, GpR includes too few program-specific outcome indicators, too few overall outcome indicators, and almost no output-quality indicators. Developing more indicators of expenditure effectiveness is vital to improve the GpR system. There is also scope to improve performance information by developing equity indicators. 96. Outcome indicators are used to set targets. Under GpR, outcome indicators such as rates of malnutrition, poverty, crime, and literacy have been developed at two main levels76 as the basis for targets. The first is the level of governmentwide plans such as the PGG. The second is the institutional level, where ministry/agency plans specify so-called strategic outcomes (resultados estratégicos) and institutional outcomes (resultados institucionales), which are intended to be outcome targets. a) Measuring Effec veness 97. The existing targets suffer from two challenges. First, many indicators that are labelled as outcomes (resultados) in fact refer to outputs. Second, most of the actual outcome indicators are for high-level objectives to which multiple programs (and often multiple ministries) contribute. As a result, they do not accurately capture the effectiveness of specific programs or those programs’ constituent outputs. 98. The first of these challenges arises from the ministry-level understanding of GpR and not from the GpR’s conceptual framework. For example, the Ministry of Education uses the following institutional result: “By 2023, the provision of early integral development services to children has increased by 8.6 percentage points.”77 This clearly refers to an output rather than an outcome. Many other result indicators are also not based on outcomes even though the GpR manual stipulates that “resultados” should refer to outcomes. The issue is the imperfect understanding and implementation of the framework at the ministry level. 99. The second problem is the link between government programs and indicators. For example, the Ministry of Economy has five main programs, including a program for consumer protection and another for the promotion of SMEs. However, the ministry’s handful of actual outcome indicators is limited to poverty rates, foreign direct investment levels, and Guatemala’s rating on global 76 Indicators in sectoral plans are essentially derived from those used at the other levels. 77 “Para el 2023, se ha incrementado la atención a niños con desarrollo integral temprano en 8.6 puntos porcentuales.” 49 competitiveness indices. As a result, four of the five main programs—including the two mentioned above—have no outcome indicators related to program effectiveness. The poverty rate is an important indicator, but it is far too broad to gauge the impact of a consumer-protection program. Although most government agencies face similar challenges, some line ministries have ample program-specific outcome indicators. The Ministry of Health and the Ministry of Education both use multiple program-specific outcome indicators, such as literacy and numeracy rates for school-age students and one-year survival rates for HIV patients. 100. The requirement to have at least one agency-wide outcome indicator may have contributed to the weak link between indicators and outcomes. Although this is principally an implementation problem, the design of the GpR system may have contributed to it in one respect. Unlike program- based budgeting systems in many other countries, GpR does not ask ministries to develop outcome indicators that are explicitly associated with specific programs. Under GpR, only the development of outcome indicators at the institution-wide level or higher is required. 101. The virtual absence of output quality indicators is a related problem . The main types of output quality indicators are measures of the timeliness of service provision, measures of conformity with service standards, and measures of client satisfaction. GpR includes almost no indicators of any of these types.78 102. Output quality indicators are useful because they can serve as proxies for outcomes. Although output quality indicators do not measure outcomes directly, higher-quality outputs are more likely to achieve their intended outcomes. Output quality indicators are particularly useful in cases where it is not possible to measure outcomes directly or when outcome indicators are heavily influenced by external factors. 103. The lack of output-quality indicators stems more from the implementation of GpR than from its conceptual framework. The conceptual design of the system explicitly mandates that these indicators be developed, but this requirement is not followed in practice. However, the design of the system may have contributed to the problem by defining output-quality indicators too narrowly (see Annex). 104. Consequently, most programs lack information on their effectiveness. Taken together, the abovementioned challenges mean that most programs lack indicators of outcomes or output quality that would provide information on the effectiveness of the program or its constituent outputs. At the program level, performance indicators are almost entirely confined to measures of the quantity of outputs delivered, which weakens the ability of GpR to achieve its objectives of improving program effectiveness and expenditure prioritization. 105. The example of prenatal check-ups illustrates the problem. The Ministry of Health has adopted a strong output quantity indicator for prenatal care, “the percentage of pregnant women with 4 prenatal check-ups during their pregnancy according to current norm.”79 However, there are no indicators of the effectiveness of these check-ups (e.g., rates of pre-eclampsia), no measures of infant health at birth (e.g., birth weight or rate of stillbirths), and no measures of client satisfaction (e.g., how pregnant women think of the care they receive). As a result, there is no way to gauge the extent 78A rare excep on is one meliness indicator from the Ministry of Health, “porcentaje de pacientes con malaria confirmada que iniciaron tratamiento an malarico de acuerdo a la norma nacional, dentro de 24 horas después del diagnós co.” 79 “Porcentaje de embarazadas con 4 controles prenatales durante su embarazo según norma vigente .” 50 to which these check-ups benefit the women who receive them or determine what measures might be adopted to improve the quality of care. 106. Developing more and better outcome and output quality indicators should be a priority to strengthen the GpR system. However, developing such indicators requires scarce institutional resources and technical capacity. The development of more outcome and output quality indicators must therefore be a gradual process, with a focus on identifying and selecting the most relevant indicators. b) Equity Indicators 107. The lack of equity indicators is a major shortcoming in the GpR methodology. Given the magnitude of the equity problems facing Guatemala, especially deep disparities between indigenous and non-indigenous citizens and between women and men, the virtual absence of equity indicators is a serious deficiency in the GpR system. The development of equity indicators should include not only measures of output equity (e.g., school enrollment rates among indigenous and non-indigenous children), but also measures of outcome equity (e.g., literacy rates among indigenous and non- indigenous primary students). c) Use of Performance Informa on 108. Only limited use is made of the performance information generated under GpR. In interviews, representatives of line ministries reported that indicators do not inform policymaking or prioritization and that they are used only to monitor the delivery of quantifiable outputs. This is unsurprising given the lack of indicators related to program effectiveness and the absence of evaluations. MFP representatives acknowledged the limited use of performance information to inform decisions about the level of funding provided to specific agencies and programs. SEGEPLAN appears to focus on the highest-level outcome indicators rather than on those that are more relevant to monitoring the performance of specific programs and agencies. d) Indicator Transparency 109. The public availability of performance indicator information could be improved. The GpR system establishes excellent principles for the transparent reporting of performance indicators. The organic budget law and its regulations specify that indicators must be included in either or both ministry plans and accountability reports (rendiciones de cuentas). There is also an annex to the annual budget documents that reports selected performance indicators by ministry and agency. In practice, however, problems arise with the implementation of these principles. For many ministries, it is not easy (or perhaps even possible) to find the relevant plans and accountability reports on their websites, even though the law stipulates that they should be published there. Certain ministries do not report their physical targets in their accountability reports. Others publish the physical targets in annexes to their accountability reports but do not include these annexes in the documents available online. 110. The basis for the selection of indicators that are included in the indicator annex to the budget documents is also unclear. Very few outcome indicators are included, and some of the indicators that are included do not appear to be the most useful ones for the ministries concerned. Overall, there appears to be a need for better and more consistent reporting of both outcome and output performance indicators to the public and Congress. 51 6. Monitoring and Evalua on 111. The role of monitoring and evaluation under the GpR is understood to mean reviewing progress against performance targets. While monitoring and evaluation are widely regarded as essential components of a well-designed performance-based budgeting system, the meaning of those terms varies across countries. In Guatemala, monitoring tends to focus on measuring quantitative indicators, while the role of evaluation is unclear. a) Evalua on 112. Although the GpR framework includes evaluation as a key component, in practice evaluations are rare, and they do not routinely inform the prioritization process. In the international literature, “evaluation” is commonly defined as the systematic and objective assessment of a project, program, or policy in terms of its design, implementation, and results. Methodologically, this covers a range of analytic techniques, from program-logic analysis through impact evaluation. The GpR conceptual documents and the organic budget law80 both clearly intend that formal evaluation be a regular part of the system, but they fail to define evaluation clearly or provide any specifics on the methodologies to be used. Guatemala’s line ministries appear to undertake little if any evaluation, 81 and they tend to treat the term as synonymous with monitoring and focused exclusively on measuring achievements against performance targets. 113. Robust evaluation requires institutional resources that are often scarce in developing countries. Impact evaluation and other “scientific” evaluation methodologies require considerable data and resources, as well as analysts with advanced training. As a result, most developing countries that use performance-based budgeting undertake few evaluations, and the quality of those evaluations is often questionable. 114. Guatemala should adopt a gradual and pragmatic approach to develop its evaluation capacity. The authorities can begin by prioritizing relatively practical forms of evaluation such as program-logic analysis and rapid appraisal while eschewing more complex and resource-intensive methodologies such as impact evaluation and cost-benefit analysis. A gradual and highly selective approach to building evaluation capacity would require the prior development of an evaluation strategy and the subsequent provision of concrete guidance and training to ministries on the practical evaluation methodologies that they will be expected to apply. The institutional arrangements for defining the theoretical framework and carrying out the assessments vary from country to country (see (Krause, Lopez-Acevedo, & Mackay, 2012) for more in-depth discussion). b) Monitoring and the Role of Performance Targets 115. Performance indicators and targets are a central feature of GpR. Monitoring is generally understood to mean reviewing and interpreting indicators82 to determine performance levels and 80 Ley Orgánico Reglamento Art. 2. 81 This is an assessment confirmed by the 2018 PEFA, which observes (p. 62), "a la fecha de la evaluación, ni los ministerios sectoriales, ni el MINFIN o SEGEPLAN habían realizado dentro del periodo de análisis evaluaciones independientes de eficacia y eficiencia de los programas presupuestarios incluidos en el presupuesto." 82 For example, as the OECD defines it in its Glossary of Key Terms in Evaluation and Results Based Management , monitoring is "a continuing function that uses systematic collection of data on specified indicators to provide management and the main stakeholders of an ongoing development intervention with indications of the extent of progress and achievement of objectives and progress in the use of allocated funds." 52 trends. GpR defines monitoring narrowly as assessing progress against a target. Performance targets are a central feature of GpR. Indeed, the system does not clearly distinguish between performance indicators and performance targets but instead assumes that everything that is measured must also have a target. The consequence is a system with a very large number of performance targets, most of which are quantitative. 116. Whether Guatemala benefits from GpR’s extensive reliance on performance targets is unclear. The theory of performance targeting is that targets can improve performance only if: (i) there is a mechanism for determining appropriate targets that are ambitious but not unrealistic; and (ii) performance against targets is carefully monitored, including by central agencies that will investigate serious failures to achieve targets and impose consequences as necessary. 117. The use of performance targets does not seem to be achieving its desired objectives. It is not clear that the above conditions are met in Guatemala. Discussions with representatives from a sample of ministries suggest that in many ministries the relevant service-delivery units set the numerical values of their physical targets without review by, or negotiation with, the respective ministerial planning or budget units, SEGEPLAN, or the MFP. There also appears to be little ex post review or accountability for performance against those targets. 118. Targets and funding levels should be agreed jointly. In principle, targets should also be calibrated to reflect the available funding. This requires that the numerical value of targets be set during the budget process, when the funding decisions are made. While in principle this is already the case for the physical targets, other outcome and output targets are set during the planning process, as plans are elaborated prior to budget preparation and without the discipline of the budget constraint. 119. The appropriateness of setting targets for every performance indicator is debatable. Many performance indicators, particularly for outcomes but also for a significant number of outputs, are clearly important to measure, yet it is difficult or even impossible to set meaningful targets because of the government’s limited control over the variables involved. 120. Performance monitoring should involve more than assessing rates of target fulfillment. While other countries also rely on a target-based concept of performance monitoring, many do not view performance monitoring exclusively through the lens of measuring target fulfillment. In those countries, performance monitoring is understood to involve analysis (e.g., trend and comparative analysis) of performance indicators that have no dedicated targets. The authorities should consider reducing the number of performance targets, focusing more attention on a narrow strategic set of targets, and building mechanisms to monitor indicators for which targets have not been set. 7. GpR in a Compara ve Perspec ve 121. Performance-based budgeting systems vary across countries, and GpR has both similarities and marked differences from the approach used by other countries. The Annex presents a detailed comparison of Guatemala’s system with those of four other countries, including two in Latin America and two advanced OECD countries. The findings are summarized in Table 6. The three areas with the most significant differences are: (i) the planning/budgeting relationship; (ii) the role of performance targets; and (iii) the role of evaluation. Three of the four comparator countries do not share the notion that it is the function of planning to estimate budget requirements to achieve plan objectives. With respect to performance targets, there is a marked difference between the Latin American comparators—both of which share Guatemala’s view that targets should be set for all performance 53 indicators—and the two advanced OECD countries, both of which take a selective approach to target- setting. The role of evaluation also differs significantly across the four countries. Table 6. Interna onal comparisons of selected features of performance-based budge ng Guatemala Perú México Australia France Explanation Planning and Budgeting Relationship Plans estimate Before budgeting starts, planners financial needs perform a bottom-up estimate of Yes Yes No No No before funding needs. budgeting Indicators and Target Each program System design requires, as far as should have a possible, the development of No No Yes17 Yes Yes full suite of outcome and key output indicator indicators explicitly linked to each program. Clear indicator/target No No18 Yes Yes Yes distinction Targets for all Targets are set for all or most Yes Yes Yes No No indicators indicators. Monitoring and Evaluation Monitoring Monitoring is understood as focused on measuring target fulfilment. Yes Yes19 Yes No No target fulfillment Evaluation is Concept/design documents and considered a manuals identify evaluation core (defined as formal analysis that Yes Yes Yes No No component of extends beyond reviewing the system indicators) as an essential part of the system. Significant Evaluations are performed regularly evaluation by an autonomous body (as activity No Yes20 Yes No No opposed to isolated evaluation activities conducted within agencies) 8. The Impact of GpR 122. The authorities have made important progress in designing and implementing the GpR system. Budget preparation and execution have been successfully moved to a program basis, with a broad suite of plans, program-based budget documents, and indicators. Supporting changes to the legal system and financial management information system have been well-designed and comprehensive. 123. The most important question, however, is to what extent has GpR succeeded in improving expenditure prioritization, effectiveness, and efficiency. A 2019 review by the World Bank Independent Evaluation Group83 found that “although progress may have been made in the formal 83Guatemala: Enhanced Fiscal and Financial Management for Greater Opportunities: Project Performance Assessment Report , IEG: p. 10. 54 adoption of results-oriented budgeting, practices and outcomes do not reflect this, especially outside the Ministries of Finance and Health … form does not replace substance.” Nevertheless, it should be noted that there is no comprehensive methodology for assessing the benefits generated by performance-based budgeting systems. Measuring changes in the allocative efficiency, technical efficiency, and effectiveness of public spending is inherently challenging, and isolating the impact of performance-based budgeting on high-level outcomes is nearly impossible given the numerous other variables involved. 124. Reviewing the design and implementation of a performance-based budgeting system can shed light on its overall quality and give a broad indication of its impact. This chapter has examined the design and implementation of the GpR to determine its likelihood of achieving its intended objectives. Ideally, such an assessment should be complemented by soliciting stakeholders’ views on the impact of GpR, but conducting a survey of government practitioners was not feasible within the scope of the PFR. However, interviews with key stakeholders have helped shed light on the overall quality of the system.84 125. Stakeholders acknowledged the limited use of performance information in the budget process. At the central level, respondents reported that performance information was rarely used to inform budgeting. MFP representatives acknowledged that the ministry generally does not use performance data during budget preparation and that performance against the physical targets is not part of the interagency dialogue during budget preparation. MFP representatives believed that monitoring progress against physical targets was a function for SEGEPLAN, but SEGEPLAN representatives made it clear that they are not involved either in setting or monitoring these targets. 126. Stakeholders also noted the weak link between planning and budgeting. SEGEPLAN representatives reported being unsatisfied with the extent to which the plan impacts the budget and suggested that it would be useful to reform the budget law to better align planning and budgeting. Several other interview subjects expressed concerns regarding SEGEPLAN’s limited institutional capacity. 127. Strengthening the link between planning and budget requires first determining whether the problem lies in the design or the implementation of the GpR. In countries with similar planning- based prioritization models, concerns about the failure of the budget to sufficiently follow the plan are often accompanied by calls for measures to compel greater adherence. However, it is essential to determine whether the disconnect between planning and budgeting is rooted in the model itself or in its implementation. If planning is financially unconstrained and fails to consider baseline expenditures, it will be much more difficult for the budget to closely follow the plan. 128. Stakeholders acknowledged that GpR implementation might have been faster than warranted, that spending ministries still lack a proper understanding of the system, and that a renewed effort to strengthen institutional capacity is necessary. Several former officials who played notable roles in the initial years of the GpR expressed the view that implementation had been too rushed, that entities did not sufficiently understand the principles and objectives involved, and that progress in 84During the fact-finding mission, the team met with government officials from the directorate of the budget, public accountancy, fiscal transparency; and fiscal policy all in the Ministry of Public Finance. The team also met with budget officials from the ministries of health, social development, education, and transport. Additionally, the team also met with officials from the controller’s office, SEGEPLAN, previous office holders in charge of GpR, and a local think tank. 55 strengthening the system had stalled early on. They suggested that a revitalized effort to expand and improve GpR should be supported by a major training program directed at line agencies. 129. Stakeholders at spending ministries acknowledged some benefits of the GpR system. Most ministry officials interviewed reported that the system of physical targets plays a useful role in promoting output performance. Several respondents who had been through the early stages of the reform said that the prior exercise of identifying outputs (productos and subproductos) had helped make their ministries more client oriented. Many representatives of spending ministries and central agencies also expressed the view that uncertainty about the release of budgeted funds significantly weakens the focus on performance. Under the cash-rationing system, ministries frequently fail to receive the full amount appropriated in the budget, making it much harder to concentrate on results. 9. The Way Forward 130. The analysis of the design and implementation of GpR presented above reveals significant opportunities to improve the system, both through direct and complementary reforms. Improving performance information is especially crucial to the further development of the system. More program-specific effectiveness indicators are needed to measure the quality of outcomes and outputs. Equity indicators should also be developed, both for outputs and outcomes. Regular evaluation mechanisms should be gradually introduced into the system, with a focus on the most practical methodologies given Guatemala’s institutional capacity. 131. Performance targets should be highly selective. Some outcomes are not sufficiently under the government’s control for target-setting to be useful. The government must also avoid establishing more targets than it can realistically define, monitor, and take remedial action to address if they go unmet. Moreover, performance information must systematically inform the budget process, and the authorities should create a mechanism for performance dialogue between the MFP and spending ministries during budget preparation. 132. Policymakers must reassess their approach to planning and prioritization. An effective prioritization mechanism must distinguish between baseline and new spending and operate within the constraints of budgetary resources. An MTBF could incorporate these elements while building on its valuable contribution to developing the presupuesto multianual, which is now included in the budget documents. The MTBF should include estimates of medium-term baseline expenditures, the total expenditure envelope, and the available fiscal space for new spending. These estimates would provide a strong framework for making better strategic decisions around new spending and creating practical mechanisms to closely monitor baseline spending. 133. Rethinking planning and prioritization could also involve reconsidering the current planning model. Plans prepared prior to the budget can inform resource-allocation decisions. Planning that aims to determine resource allocation but is carried out without regard to budget constraints is less useful. Moreover, plans should always be as simple and practical as possible. 134. Guatemala’s achievements in performance-based management exceed those of its developing peers. None of the issues identified above detract from Guatemala’s considerable progress in implementing a sophisticated model of performance-based budgeting, along with supporting changes in legal, information technology, and other systems—and in a relatively short time. Guatemala’s achievements in this area compare favorably with those of many other countries. Recommendations for improving the GpD system are summarized in Table 7. 56 Table 7. Recommenda ons Performance Indicators More outcome indicators Outcome indicators are fundamental to assess expenditure effectiveness. There are too few outcome indicators, especially those that report on the effectiveness of specific programs or their constituent outputs. More output quality indicators Output quality indicators (e.g., timeliness, client satisfaction and compliance with service standards) are important in their own right and can substitute for outcome indicators that are unavailable due to measurement issues or the influence of external factors. More equity indicators Measures of equity in the distribution of outputs and outcomes (e.g., between men and women or between indigenous and non-indigenous households) should be embedded in performance indicators. Monitoring and Evaluation Selective use of performance Not all performance indicators are suitable for target-setting, and the targets government should not establish more targets than it can realistically develop and monitor. Strengthened monitoring Monitoring should go beyond measuring performance against targets and mechanisms should include appropriate mechanisms for analyzing performance in greater detail (e.g., via time series or cross-sectional analysis). Evaluation developed. Evaluation is effectively nonexistent. The government should begin establishing evaluation mechanisms by prioritizing the simplest and most practical methodologies. Planning and Budgeting More systematic use of The use of performance information in budgeting and management should performance information be strengthened by integrating a “performance dialogue” into the budget preparation process. Development of a medium-term The government should develop a full medium-term budgeting framework budgeting framework that recognizes the difference between baseline and new spending and uses robust medium-term estimates of baseline expenditures. Strengthening of expenditure The planning and budget process should be modified to explicitly recognize prioritization processes that plans must respect the budget constraint, and expenditure prioritization must distinguish between baseline and new spending. Simplification of the planning The planning model should be simplified to reduce the use of highly complex model concepts that are not necessarily well understood. C. Integra ng Climate Commitments into the Budget 135. Despite its low contribution to global emissions, Guatemala is highly vulnerable to the impacts of climate change. Guatemala accounts for just 0.08 percent of global greenhouse gas (GHG) emissions. In 2021, it ranked 172nd out of 237 countries in CO2 emissions per capita.85 However, about 75 percent of the population is exposed to climate threats such as floods, droughts, and landslides, adversely affecting livelihoods and economic activities. The economic impact of climate change is estimated at between 2.13 percent and 63.63 percent of cumulative GDP86 (MARN, 2021). 136. This section provides an overview of Guatemala’s governance framework for climate change and related planning and budgeting practices. Guatemala has made important efforts to create a 85 https://ourworldindata.org/grapher/co-emissions-per-capita 86 Depending on the climate scenario and period analyzed (MARN et al., 2021). 57 legal and policy framework for climate change, which currently includes a Framework Law of Climate Change (Decreto 7-2013), a Climate Change policy, a National Climate Change Action Plan, and other policy documents. However, the government still lacks an effective instrument for allocating resources for climate change, and climate funding depends heavily on donor contributions. 137. According to the Framework Law of Climate Change, the Ministry of Environment and Natural Resources (Ministerio de Ambiente y Recursos Naturales, MARN) and the Secretariat of Planning and Programming of the Presidency (Secretaria de Planificación y Programación de la Presidencia, SEGEPLAN) are the central agencies for climate change, while the MFP should prioritize allocating resources to activities related to climate-change adaptation or mitigation. The Framework Law of Climate Change (Decreto 7-2013) establishes the roles and responsibilities of various stakeholders involved in achieving climate-related goals. The National Climate Change Council (Consejo Nacional de Cambio Climático, CNCC), chaired by the Presidency of the Republic, is responsible for the regulation, supervision, and monitoring of national climate change policies, strategies, action plans, and mitigation and adaptation programs. MARN and SEGEPLAN form the Secretariat of the CNCC. SEGEPLAN is tasked with coordinating the planning and programming process for public investments at the sectoral, public, and territorial levels, ensuring that the different public entities contribute to the objectives of this law through their policies, plans, programs, and projects. SEGEPLAN and the MFP should prioritize allocating economic resources to activities related to climate change. MARN is responsible for providing guidance to other national and subnational public entities on climate mitigation and adaptation. The National Coordinator for Disaster Reduction ( Coordinadora Nacional para la Reducción de Desastres, CONRED) and the National Institute of Seismology, Volcanology, Meteorology and Hydrology (Instituto Nacional de Sismología, Vulcanología, Meteorología e Hidrología, INSIVUMEH) are tasked with developing guidance on reducing climate vulnerability, strengthening risk management, and building adaptive capacity. 138. However, these government agencies have yet to fully assume their responsibilities. Despite MARN’s role as the lead agency for the climate agenda, it is not sufficiently empowered to mobilize other government institutions to act. In practice, MARN’s Climate Change Directorate, which has fewer than 20 staff members, is responsible for leading the preparation of climate-change reports, managing information systems, and advising government agencies on climate-related matters. The project unit at MARN is responsible for mobilizing development finance for specific climate projects. Neither MARN nor SEGEPLAN coordinates the government’s overall effort on the climate agenda, nor do they regularly monitor the progress of activities carried out by other agencies. The MFP does not yet have a mechanism to analyze climate-related needs and prioritize the allocation of resources accordingly. 139. Government agencies have a limited understanding of climate change and insufficient information to guide planning. Climate action is often understood narrowly as environmental policy and forest protection, and agencies have little knowledge of climate risk affecting the population and economy. INSIVUMEH conducts vulnerability and impact studies and provides forecasts and scenario analyses for climatological variables from 2010 to 2099, as well as climate projections for future periods (2039, 2040-2069, 2070-2099), but this information is available only upon request and is underutilized. 140. Although the National Climate Change Action Plan (Plan de Acción Nacional de Cambio Climático, PANCC) and the Nationally Determined Contributions (NDC) under the Paris Climate 58 Agreement identify priorities and actions for various stakeholders, there is a lack of ownership of these documents among government agencies. The specified actions are not effectively integrated into agencies’ strategic plans or annual plans, nor is implementation progress regularly monitored. During the planning process, government agencies often use only the Framework Law of Climate Change to determine the climate actions they need to take, while the PANCC and NDCs are treated at indicative, if considered at all. The K’atun National Development Plan and the Government’s General Policy establish a set of priorities for climate action, but these documents are broad and do not specify responsibilities, timeframes, or concrete actions. As a result, they do not serve as a guide for allocating adequate resources, coordinating actions among different entities, or evaluating progress effectively. The PANCC is the only instrument that establishes concrete actions, goals, result indicators, prioritized territories, timeframes, and responsible parties. However, the PANCC includes numerous activities, with multiple actors responsible for each activity, which makes implementation challenging. Moreover, there is no clear mechanism for monitoring progress on climate action. 141. The government lacks an instrument to guide the allocation of resources for climate activities. The Framework Law of Climate Change requires that all public institutions allocate, within their budget, the necessary resources to fulfill their legal mandates. It also stipulates that SEGEPLAN and the MPF should prioritize allocating resources to agencies that formulate climate-related plans, programs, and projects. In Guatemala, each public institution prepares an Institutional Strategic Plan (Plan Estratégico Institucional, PEI) that defines its strategic vision in line with the K’atun National Development Plan guidelines, the General Government Plan, and national and sectoral policies and laws. Based on the PEI, institutions prepare the Multiannual Operating Plan ( Plan Operativo Multianual, POM), which breaks down the PEI’s strategic objectives into specific goals and defines the actions, projects, and programs that will be carried out to achieve them. Finally, each institution prepares their Annual Operating Plan (Plan Operativo Annual, POA) based on the POM and the budget ceiling indicated by the MFP. The guidelines issued by the MFP and SEGEPLAN do not contain specific guidance on planning and budgeting for climate-related activities. 142. Rather than mainstreaming climate change into planning and budgeting, the government relies heavily on donor funding to finance climate-related activities. According to the Third National Communication on Climate Change (MARN, SGCCC, & PNUD, 2021), 90 donor-funded projects were carried out from 2015 to 2020,87 with a total value of approximately US$332 million, or an average of US$55.3 million per year. However, a UN Climate Change Public Expenditure Report (Programa de las Naciones Unidas para el Desarrollo (PNUD), 2018) estimated that central government spent GTQ 2576.8 million (about US$335.08 million) on climate-related priorities during 2014-2017, or an average of GTQ 644.2 million (USD 83.77 million) per year.88 These figures include that about two- thirds of the government’s adaptation and mitigation funding comes from donor contributions. 143. The government has developed a methodology to tag climate expenditures; however it has only been implemented at the MARN. Currently, climate programming is often perceived as an additional expenditure rather than being mainstreamed into the existing activities of institutions. The Thematic Classifier for Climate Change Mitigation and Adaptation, when fully implemented across public 87 47 projects were funded by multilateral funds, 35 by bilateral contributions, 4 by international financial institutions, and 4 by other donors. 88 The analysis was conducted using the UNDP's Public and Institutional Climate Review methodology, complemented by OECD and BIOFIN approaches. The Ministry of Finance led the process together with the Technical Budget Directorate. Expenditures were defined according to the PANCC and validated by MINFIN at the request of MARN. 59 institutions, will indicate how much the governments spends on climate-related activities and reveal opportunities to mainstream climate change in the budget process. To date, only MARN has implemented the classifier, but it is expected to be rolled out in additional priority agencies in the near term. 144. Water and sanitation, agriculture, and the environment are the top three sectors in terms of investment in climate change. Based on a review of the investment projects executed in 2022 vis-à- vis the sector goals indicated in PANCC, out of 14,908 investment projects an estimated 2,044 (13.7 percent) contribute to climate mitigation and adaptation.89 Among these, the top three sectors are water and sanitation (66 percent), agriculture (15 percent), and the environment (7 percent).90 In the water and sanitation sector, most projects focus on expanding and improving water infrastructure for human consumption and basic sanitation, designing and constructing water-collection works, increasing water-purification capacity, and establishing and maintaining treatment plants in priority areas at the municipal level. In the agricultural sector, most projects are focused on food security, boosting agricultural production, and implementing reforestation programs. Typical projects include food support to the municipal food and nutrition security offices, increasing the production of basic grains by providing herbicides to farmers in the municipalities, and supporting forest conservation and reforestation through the municipal environmental management units. In the environmental sector, most projects are focused on watershed conservation, the conservation of ecosystems through reforestation and the protection of native species, and strengthening emergency preparedness and risk-management strategies at the municipal level (Figure 36). Figure 36. Climate-relevant public investment by sector 145. Local projects account for almost 89 percent of all climate-related investment, but they are not guided by a national plan. In 2022, 1,376 of the 2,044 climate-related investment projects were 89 This is a rough estimate based on review of publicly available information on the SNIP. The review was done by sector. If the name of an investment project is partially or completely aligned to a specific goal of the PANCC for that sector, the project is considered -for the purpose of this review – contributing to climate mitigation or adaptation. It is worth noting that SNIP only provides the name of the project, therefore the match was only done based on the alignment of the name of the project with the sector goal established in PANCC. Secondly, this analysis only considers whether a project in its entirely contributes to climate change. It does not estimate the proportion of the project that is relevant for climate change. 90 The value is calculated using the total value of each project. This analysis does not estimate the proportion of the project that is relevant for climate change. 60 carried out by local governments, 624 by local development councils (consejos de desarrollo), 20 by the Institute of Municipal Development (Instituto de Fomento Municipal), and 23 by national-level government agencies ( 146. Figure 37Error! Reference source not found.).91 Despite the important role of local governments in this area, the UN Climate Change Public Expenditure Report found that the allocations made by local governments and development councils are not aligned with the goals established in PANCC (Programa de las Naciones Unidas para el Desarrollo (PNUD), 2018). 147. Although disaster risk analysis is performed during the appraisal stage for investment projects, it is based on historical patterns and does not consider future climate scenario or adaptation needs. All public institutions are required to conduct a disaster risk analysis during project appraisal using an instrument called the Risk Management Analysis for Public Investment Projects ( Análisis de Gestión de Riesgo en Proyectos de Inversión Pública, AGRIP), which contains a form that project designers must complete regarding the historical weather patterns and natural disasters that have occurred in the proposed project location. This implies that investment decisions may not consider the possible future impacts of climate change, which increases their vulnerability to extreme weather events. Figure 37. Climate-relevant public investment by agency type Recommenda ons 148. Practical training on how to interpret technical information and mainstream climate-change considerations could improve planning and budgeting. Understanding future climate impacts is essential for public institutions to plan accordingly and mainstream climate considerations into their plans and budgets. The government could organize a series of practical trainings to help institutions identify risks and opportunities associated with climate change, assess the vulnerability of existing activities, and develop appropriate adaptation measures. For example, the Ministry of Agriculture, Livestock and Nutrition is helping small farmers purchase catastrophic agricultural insurance to 91 The value is calculated using the total value of each project. This analysis does not estimate the proportion of the project that is relevant for climate change. 61 protect them against droughts and floods. These events are likely to become more frequent and severe in the future, which will impact the cost of the insurance and the need for fiscal resources. 149. Awareness-raising and capacity-building activities at the local level are critical. MARN and SEGEPLAN have developed PLANIMUCC to provide valuable climate-related information, including the climate change vulnerability index and estimates of exposure to droughts, floods, and landslides in each municipality. However, the extent to which this information informs planning decisions at the local level is unclear. A survey could assess local governments’ awareness of these issues and capacity to utilize the tools developed by the national government. Based on the survey results, the authorities could develop practical trainings for local officials and improve the quality of the tools. 150. Climate vulnerability and risk should be analyzed and managed in public investment projects. SEGEPLAN could partner with institutions such as INSIVUMEH to update the methodology of AGRIP. INSIVUMEH already conducts vulnerability and impact studies and provides climate projections for future periods. It can help develop methodology for vulnerability and risk assessment for investment project proposals, which will screen the project’s sensitivity and exposure to certain climate change– induced hazards, and analyze the likelihood of the hazard occurring and the severity of the impact on the success of the project should the hazard occur (The World Bank, 2022). SEGEPLAN can also develop guidelines to help government agencies design adaptation and risk-management measures based on the results of the assessment. 151. As the government updates the PANCC, it is important to create a participatory process involving all relevant institutions and prioritize actions to make the plan feasible for implementation. The plan requires stakeholder input to promote broad-based ownership during implementation. Moreover, a rigorous prioritization exercise is needed to ensure that only a limited number of actions are included in the plan and that responsibility for implementing each proposed action is clear. A financing strategy should also be discussed during the preparation or updating of the plan. 152. The government should consider implementing a simple monitoring and reporting mechanism for climate activities based on existing information systems. Progress on climate activities is currently compiled on an ad hoc basis with no standard format, which makes it difficult to track achievements against targets. The government could consider using data and information available in existing information systems. The information in the SNICC could be enriched with data from the National Public Investment System (Sistema Nacional de Inversión Pública, SNIP), a repository of investment projects with detailed information on their scope and objectives, as well as physical and financial implementation progress. SIPLAN only provides information about PEI, POA, and POM for all government institutions. The wealth of information available through SNIP and SIPLAN, however, provides a robust foundation for monitoring and planning investment projects that are dedicated to addressing climate change. It is also important to assign clear responsibility to a public institution to carry out related monitoring and evaluation. 153. The monitoring mechanism would be more effective if it were supported by a transparency and accountability framework. At a minimum, clear responsibilities should be assigned to prioritize climate actions, along with results indicators and reporting mechanisms. To strengthen accountability, progress reports should be submitted to a higher decision-making authority such as the CNCC or Congress for review and discussion. The government could also make the progress report publicly 62 accessible and organize dialogue and discussions with civil society to obtain feedback and enrich the monitoring process. V. Fiscal Risks This chapter defines fiscal risks and reviews Guatemala’s iden fica on and es ma on methods. It provides an overview of risks already included by the government in its fiscal risk statement and broadens the fiscal risks analysis to examine debt-related con ngent liabili es. The review and expansion of fiscal risk analysis is based on interna onal good prac ces and reports from the World Bank, IMF, and peer countries that have implemented fiscal risk frameworks for similar exposures. Although not legally mandated, the government undertakes an extensive annual review of the country’s fiscal risks, 92 the results of which are included in the budget proposal. It currently reports eight sources of fiscal risks: (i) macroeconomic variables, (ii) public debt, (iii) municipal governments, (iv) non-financial SOEs, (v) the pension system, (vi) judicial claims against the government, (vii) natural disasters, and (viii) natural resources. A. What are Fiscal Risks? 154. Fiscal risks reflect the extent to which actual fiscal outcomes may differ from the estimates on which the budget is based. The probability and magnitude of fiscal risks can have a significant impact93 on public finances. Higher-than-expected public spending and/or lower-than-expected revenue can widen the budget deficit and alter the government’s financing needs. Inadequate fiscal risk management can reduce the scope for countercyclical fiscal policy and in extreme cases may even compromise fiscal sustainability. Incorporating these uncertainties into the budget formulation process is a good practice in public financial management. 155. Fiscal risks can be explicit, implicit, direct, or contingent. Explicit liabilities represent a potential legal obligation for the government, while implicit liabilities are based on expectations about government intervention (e.g., to support a distressed SOE in a key sector of the economy). While the government has no legal obligation to incur implicit liabilities, there may be a strong political or economic incentive to do so. Direct liabilities are predictable obligations, while contingent liabilities are triggered by a discrete⁠ but uncertain⁠ event. Table 8 provides specific examples of the government’s exposure to different types of fiscal risk. 92See https://www.minfin.gob.gt/images/archivos/proypre23/Inicio%201.htm, Novena Parte: “Riesgos Fiscales” 93Fiscal risks tend to be biased toward the downside. While positive fiscal shocks also occur, governments are more prone to anticipate these and incorporate them into their forecasts than negative ones, leaving the balance of risks skewed toward the downside. (IMF, 2016) 63 Table 8. Fiscal risk matrix Direct Liabilities Contingent Liabilities (Obligations within government (Obligations beyond government control) control) Explicit Liabilities *Sovereign debt (loans contracted *State guarantees for non-sovereign (recognized by law or and securities issued by the central borrowing by subnational governments and contract) government) other obligations by subnational governments *Expenditure composition and public and private-sector entities (e.g., (nondiscretionary spending) development banks) *Expenditures that are legally *Umbrella state guarantees for various types binding in the long term (e.g., civil- of loans (e.g., mortgage loans, student loans, service salaries, loans, and agriculture loans, small business loans) pensions) *Trade and exchange-rate guarantees issued by the state *State guarantees on private investments *State insurance schemes (e.g., deposit insurance, income from private pension funds, crop insurance, flood insurance, war-risk insurance) Implicit Liabilities *Future public pensions *Defaults by subnational governments or by (expectations by the *Social security schemes public or private entities on non-guaranteed public and/or moral *Future healthcare financing debt obligations of the *Future recurrent costs of public *Bank failures government) investment projects *Clean up liabilities of entities being privatized *Failure of a nonguaranteed pension fund, employment fund or social security fund (protection of small investors) *Environmental recovery, disaster relief, military financing. B. Implica ons for Fiscal Policy 156. Identifying, quantifying, and publishing fiscal risks is important both for the government and its stakeholders. The government must track fiscal risks to deploy effective mitigation strategies. Key stakeholders, such as private, public, domestic, and international creditors and rating agencies, also use this information to guide lending decisions and assess credit risk, both on the part of the government and the entities exposed to fiscal risk. Monitoring fiscal risks allows the government to disburse financing more efficiently by linking allocations to the risk associated with each entity. It also enables policymakers to formulate risk management strategies to present to external stakeholders during discussions around external financing or perceived sovereign credit risk. Greater clarity on the nature, size, and mitigation options for different types of fiscal risk can improve the perception of credit risk and lower funding costs for the government. 157. Identifying and quantifying fiscal risks allows the government to better design mitigation strategies and monitoring mechanisms. Tools to manage fiscal exposure include: (i) direct controls, ceilings, and caps; (ii) regulations and indirect instruments; (iii) risk transfer, risk sharing and insurance mechanisms; and (iv) provisioning. Given the diverse sources of fiscal risk, a range of tools should be employed both by the private and public sectors to reduce the size and probability of fiscal risks and safeguard the public finances during different types of crises. Fiscal risks should be monitored 64 regularly to track their evolution and enable the government to react proactively to deteriorating situations. 158. Fiscal risks need to be explicitly considered when setting fiscal rules or targets. The choice of fiscal rule should be appropriate to the country’s macroeconomic circumstances and risk profile. Escape clauses should be used parsimoniously, and correction mechanisms should be automatic. Fiscal targets should not encourage excessive risk-taking and should allow the authorities to identify and prudently manage the risks that are taken. Ensuring the effectiveness of fiscal rules and targets typically requires greater fiscal transparency, as well as stronger monitoring and evaluation, within the framework of its risk management strategy. C. Fiscal Risks in Guatemala A comprehensive framework for managing fiscal risks requires clear objec ves and sound governance arrangements. Plans for managing assumed con ngent liabili es (or assets) should be embedded in sound governance arrangements. This includes a robust legal and ins tu onal framework, as well as effec ve risk mi ga on and monitoring mechanisms. 1. Managing Fiscal Risks 159. The government began performing its own risk analyses in 2016, and the first report was included as an attachment to the 2017 general budget. This was preceded by an IMF Fiscal Transparency Evaluation94 that took place in the same year. In 2018, the MFP’s internal regulations95 were updated to assign responsibility for fiscal risks analysis to the Macro and Fiscal Analysis Department. The unit in charge of analyzing the fiscal impact of investments, the National Agency for Analyzing the Development of Economic Infrastructure (Agencia Nacional de Alianzas de Desarrollo de Infraestructura Económica, ANADIE), also provides risk estimates linked to public-private partnerships (PPPs). However, there is no legal framework for the coordination, management, and reporting of fiscal risks. Currently, a fiscal risk report is drafted in the second quarter of the fiscal year and delivered during the third quarter to the Technical Directorate of the Budget, which attaches it to the draft budget for the next fiscal year. Guatemala’s fiscal risk report has steadily expanded its coverage of risks, and it uses the structure of fiscal risk statements suggested in the IMF’s 2016 Fiscal Transparency Evaluation. The 2023 fiscal risk report covers eight different types of fiscal risks, which it assesses in qualitative terms. 160. Guatemala’s public finances are exposed to a variety of fiscal risks, but risk analysis is limited. The fiscal risks report attached to the annual budget law for 202396 includes the following fiscal risks: (i) macroeconomic risk (including deviations from the macroeconomic projections, commodity prices, and the impact of COVID-19), (ii) public debt risks; and (iii) explicit and implicit contingent liabilities tied to municipalities and SOEs. In the context of fiscal risk analysis, only the following operations approved by Congress are deemed to constitute public debt: multilateral loans, bilateral loans, debt, and government-guaranteed SOE debt. Debt to the Central Bank of Guatemala (BANGUAT) is excluded. The report also includes an overview of the direct liabilities associated with the Guatemalan pension system and explicit contingent liabilities due to legal claims against the state, as well as 94 (International Monetary Fund, 2016) 95 See Acuerdo Gubernativo Número 112-2018m Articles 56 and 58 under https://www.minfin.gob.gt/images/downloads/dcp_marcolegal/constitucion/acuerdogub112_2018.pdf 96 See https://www.minfin.gob.gt/images/archivos/proypre23/Inicio%201.htm, Novena Parte: “Riesgos Fiscales” 65 liabilities caused by natural disasters. The last part of the 2023 report includes fiscal risks associated with natural-resource revenues. The 2024 report added fiscal risks arising from public-private partnership (PPP), institutional risks, and state assets. In addition, the report now classifies risks according to their likelihood and potential fiscal impact, and many risks have more precise impact estimates. The next step would be to aggregate the estimated impacts with the respective probabilities to construct a distribution of the total expected loss. 161. Guatemala has yet to establish a comprehensive formal framework for estimating, managing, and reporting fiscal risks. Such a framework requires clear objectives and sound governance arrangements. While the government uses guarantees to support only one of its SOEs and includes them in fiscal risk report, it should expand the report to include on-lending and to cover other priority sectors. Managing the assumed contingent liabilities and assets requires sound governance arrangements, including a clear and comprehensive legal and institutional framework, as well as effective monitoring mechanisms and risk-mitigation tools. When natural disasters are excluded, the government’s overall exposure to implicit and explicit risks is modest (Table 9), due in part to Guatemala’s relatively low debt-to-GDP ratio. Setting up a legal framework around fiscal risks can facilitate productive financing for government-related entities and projects by enabling stakeholders to distinguish among risk levels. Strengthening the management of explicit contingent liabilities will require expanding the current legal framework to include borrowing by SOEs and municipalities, as well as the organic budget law. 162. There is a need to clearly define fiscal risks in the legislation and assign responsibilities for managing them within the government. Currently, the legal framework lacks a comprehensive taxonomy of fiscal risks that require monitoring, mitigation, and reporting. The Macro and Fiscal Analysis Department defines fiscal risks in its fiscal risk report as the factors that may cause financial results to deviate from the government’s expected fiscal position. This broad definition, however, misses important aspects of fiscal risk, such as obligations of the general government that extend beyond those of the central government. A clear legal definition would provide the basis for systematically and comprehensively accounting for fiscal risks. The legislation should explicitly assign the coordination role for fiscal risk management to the MFP and set up a governmentwide framework for collaboration between different stakeholders—the MFP, MARN, the General Controller’s Office (Contraloría General De Cuentas, CGC), BANGUAT, and ANADIE—with well-defined roles assigned to each entity. 2. Sources of Explicit and Implicit Con ngent Liabili es 163. The main sources of explicit and implicit contingent liabilities are judicial settlements, followed by non-guaranteed debt incurred by SOEs and municipalities (Table 9). Guatemala’s fiscal risk report is subject to several important caveats. PPP-related risks have been included only since 2024, and since there is only one PPP contract, the report does not include the magnitude of these risks or the probability that they will materialize. Explicit and implicit contingent liabilities are currently estimated at 3.79 percent of GDP based on current outstanding obligations (maximum exposure) for each line item, of which explicit contingent liabilities represent 3.1 percent of GDP and implicit contingent liabilities represent 0.7 percent. Guatemala’s exposure to natural disasters adds to its overall fiscal risk. 66 Table 9. Es mates of explicit and con ngent liabili es (% of 2021 GDP) Explicit CL Implicit CL Source of Risk Estimated CL Source of Risk Estimated CL 1 Legal disputes 2.95 Non-Financial SOEs 0.37 Loan 0.14 Municipalities 0.32 Guarantees PPP Contracts2 N.A. N.A. N.A. Total 3.09 Total 0.7 a) Loan guarantees 164. Loan guarantees are extended to government entities, municipalities, and strategic utilities. Currently, only one SOE, the National Electrification Institution (Instituto Nacional de Electrificación, INDE), benefits from a guarantee. This type of guarantee is extended by the government to facilitate co-financing between governments and multilaterals for loans to national SOEs. As of 2022, outstanding guarantees amounted to US$132.6 million (0.14 percent of 2022 GDP, or 1.2 percent of the public sector’s external debt), all of which were related to INDE. The government’s exposure to guarantees has remained below 0.3 percent of GDP since 2016 and has gradually declined over time. In 2001 and 2003, however, guarantees provided to the largest municipal SOE, the Guatemala City Municipal Water Company (Empresa Municipal de Agua de la ciudad de Guatemala, EMPAGUA), were called in, as the enterprise was not able to fulfill its obligations. 165. The legal framework for guarantees is outlined in Articles 63-65 of the LOP.97 The LOP states that all debt, including government guarantees, must be authorized by Congress. Approval implies a favorable technical opinion issued by the Monetary Board and the General Secretariat of the National Economic Planning Council. Several SOEs have requested guarantees, but the LOP requirements make the assignment of guarantees highly selective. Article 66 further states the need for an amortization fund at an account at the BANGUAT for the sole purpose of repaying the external debt contracted. 166. Guatemala does not have a framework to evaluate and quantify risks arising from loan guarantees. This type of analysis is not required in the legislation governing guarantees. To assess credit risk emanating from government entities, government risk managers apply either third-party methodologies, such as those used by international credit rating agencies, or internal benchmarking. Typically, credit risk evaluation at the government level is conducted by applying one or more methodologies: assigning a credit rating, statistical modeling, financial modeling, and/or structural modeling. The outputs of any of these methodologies can be translated into quantifiable risk measures, such as expected losses or market values, and presented to senior decision-makers as the basis for applying budget provisions, guarantee fees, or other risk-management tools. The results are then used as part of the feasibility analysis to determine whether to extend a guarantee and at what cost given the level of perceived risk. As an example, Box 4 shows how credit risk valuation is used in Colombia to issue guarantees to public entities98. 97 https://www.minfin.gob.gt/images/downloads/leyes_ongs/textos_legales/2_1decreto101_97.pdf 98 (International Monetary Fund, 2017). 67 Box 4. Credit Risk Valua on for Assigning Guarantees in Colombia Colombian law empowers the government to guarantee the payment obliga ons of public en es. Guarantees are issued with the concurrence of the Na onal Council for Economic and Social Policy—a group of ministers— and with the approval of the Congressional Commission on Public Credit. The Ministry of Finance and Public Credit rou nely conducts credit risk assessment of its guarantee por olio. Externally assigned credit ra ngs are used to determine the default probability and loss given default. The value of a por olio of guarantees is computed by summing up the expected loss and the unexpected loss at a 99.9- percent confidence interval. The expected loss is determined by mul plying the exposure at the me of default with the default probability and a factor represen ng the loss given default. The unexpected loss is computed using a formula that considers the weighted average life of the por olio and an asset-correla on factor that captures the por olio’s exposure to the general economic situa on. Each beneficiary is required to pay an annual risk-based fee equivalent to the expected loss for the year. The Ministry of Finance and Public Credit ac vely monitors the financial condi on of the beneficiaries and reassesses fees every year. Fees are payable for the en re dura on of the guarantee and credited to a con ngency fund, which provides the first buffer against any payments arising from guarantees.99 Source: Colombia, Ministry of Finance b) Private-Public Partnerships (PPPs) 167. The government has established a legal basis for developing PPPs. The Law on Partnerships for the Development of Economic Infrastructure and its regulations were approved during 2010-11. This legal framework encourages joint ventures between the government and the private sector for the construction and management of highway projects, the generation and distribution of electricity, and the construction and operation of ports, airports, and other public works. The legal framework specifies: (i) the institutions responsible for establishing PPPs; (ii) the functions of the ANADIE; (iii) the procedures for bidding and contracting; (iv) guarantees, including those granted by the government; and (v) the arrangements for supervision and dispute resolution. Under the law, risks arising from PPP contracts are to be shared, with the precise division set forth in each contract. 168. ANADIE, a decentralized agency, advises other public institutions in the planning, structuring, and contracting of public infrastructure projects through PPPs. ANADIE’s functions include developing PPP policies, prioritizing initiatives sought by public entities, supporting the development of feasibility and design studies, approving projects, supervising the execution and implementation of policies, reporting results, and ensuring accountability. In 2021, ANADIE published the Manual for PPP Initiatives, which includes guidelines on the phases that each initiative must complete until it is consolidated as a project. 169. Guatemala currently has one PPP underway and six prioritized projects. ANADIE has compiled a portfolio of infrastructure projects focused on administrative services, ports, highways, airports, roadways, energy, and transportation. As of end-2022, the agency had a portfolio of six prioritized projects, with five in the structuring process and one in the process of pre-qualifying bidders, totaling around US$1.6 billion (1.8 percent of GDP). The first PPP project, approved in 2022, is currently underway. This project is the Escuintla–Puerto Quetzal Highway, which is currently in the pre- 99Colombian Ministry of Finance and Public Credit. 2015. Resolución 923 de 2015. Diario Oficial No. 49.482 de 14 de abril de 2015. https://normativa.colpensiones.gov.co/colpens/docs/resolucion_minhacienda_0932_2015.htm. 68 construction phase.100 Most of the projects are formulated under the design-build-operate-transfer modality, and only in a few cases do they envisage the government establishing explicit guarantees. The current portfolio does not yet include a framework for quantifying and managing the risks arising from guarantees (i.e., minimum revenue guarantees). Table 10. Por olio of PPP Ini a ves as of 2022 Project Contracting entity Estimated Status investment (US$ million) Modernization, Efficiency and Security Ministry of of La Aurora International Airport in Communications 158 Pre-feasibility studies Guatemala City Infrastructure and Housing Road Interconnection and Urban Passenger Transport of the North- FEGUA and Municipality of 770 Pre-feasibility studies South Axis of Guatemala City/Metro Guatemala Riel Mass Public Transport System of the East-West Axis of the Metropolitan Municipality of Guatemala TBD Pre-feasibility studies Area of Guatemala Centro Administrativo del Estado en la MFP 240 Pre-qualify bidders Ciudad de Guatemala Ministry of State Administrative Center in Communications 310 Pre-feasibility studies Guatemala City Infrastructure and Housing Puerto Seco Intermodal Tecun Umán II Ministry of Economy 40 Pre-feasibility studies Ministry of Approved by the Escuintla – Puerto Quetzal Highway Communications 125 Congress. Infrastructure and Housing Preconstruction Total 1,643 170. Explicit contingencies from PPPs are limited, but risks could increase as the PPP portfolio expands over time. The legal framework allows explicit contingencies from PPPs in the form of guarantees and payments, but there is no ceiling to control the cumulative stock of explicit contingencies. Currently, the only approved PPP includes no explicit guarantees or public financing commitments. Among the six projects in the portfolio, only three are expected to receive public financing, and the explicit guarantees that may be included in other projects in the portfolio have yet to be defined. These factors indicate a moderate fiscal risk in the short term, but this situation could change with the expansion of the portfolio over time. 171. Fiscal risks emanating from PPPs have been included in the fiscal risk report since 2024. ANADIE publishes detailed information on the PPP portfolio on a regular basis on its website,101 including the financing involved, the status of projects, and documents related to the project phases. Moreover, an annual report102 has been published since 2015 with information on the progress on projects and initiatives. The fiscal risk report includes a section on risks stemming from PPPs since 2024. 100 (Agencia Nacional de Alianzas para el Desarrollo de Infraestructura Económica). 101 ANADIE. Projects https://anadie.gob.gt/proyectos/ 102 https://anadie.gob.gt/informe-anadie/ 69 Box 5. Managing Con ngent Liabili es from PPPs in Colombia The Colombian government discloses con ngent liabili es arising from PPPs in its annual report on the medium- term fiscal framework. In the early stages of the PPP program—un l 2004—obliga ons linked to PPP guarantees in the electricity, telecommunica ons, and highways sector resulted in cumula ve payments of 2 percent of GDP. The Colombian government began exploring methods to improve risk assessment and mi gate con ngent liabili es from infrastructure projects, and in 2019 the Ministry of Finance and Public Credit developed a new methodology designed to increase fiscal resilience to crises and spur investment. The ministry worked with the implemen ng agencies to apply the new methodology to projects and allocate appropriate resources to the con ngency fund. In November 2020, the Colombian government published a new sta s cal approach and new models for measuring risks for infrastructure contracts. Although intended for all contracts, this new approach is especially useful for transporta on projects. Under the PPP agreements, the government faces two cri cal sources of risk:  Cost overruns, which can materialize if the project goes beyond the estimated budget during the implementation phase due to land acquisition, environmental factors, or utilities, thereby creating an explicit liability, and  Low collections rates for toll roads, which would require the government to pay the difference between the actual toll revenue and the estimated revenue to its private partners, as well as the cost of differential tariffs for people living near the toll road, thereby creating both explicit and contingent liabilities. These efforts have helped strengthen macroeconomic and fiscal management and reduce Colombia’s vulnerability to risks stemming from PPPs. Source: Colombia Ministry of Finance and World Bank c) State-Owned Enterprises 172. There are 25 SOEs in Guatemala. The SOE portfolio comprises 14 nonfinancial municipal SOEs, eight national non-financial SOEs, and three financial SOEs (Table 11). SOEs are present in most major sectors of the Guatemalan economy, including utilities (electricity and water), services (telecommunications), and infrastructure (ports and transport), as well as commerce, banking, and finance. In 2021, total SOE assets represented 2.3 percent of GDP. The largest nonfinancial SOEs are wholly owned by the government. The four largest nonfinancial SOEs hold 96 percent of all SOE assets. INDE is the largest (57 percent of total assets), followed by the Port Enterprise of Quetzal ( Empresa Portuaria Quetzal, EPQ) (16 percent), the National Port Enterprise of Santo Tomás de Castilla ( Empresa Portuaria Nacional de Santo Tomás de Castilla, EMPORANC) (8 percent), and the financial, non- monetary Institute for the Promotion of Insured Mortgage (Instituto de Fomento de Hipotecas Aseguradas, FHA) (14 percent). Table 11. Financial statement of municipal and na onal public corpora ons (GTQ and % of GDP) Level Sector Name Year Assets Liabilities Equity Revenues Expenses Results Non Financial Public Corporations 14,726,074,930 2,592,694,883 12,112,248,463 5,545,708,090 4,809,056,105 732,539,421 1 Municipal Various Aggregated (14 entities) 2022 1,131,834,194 1,172,822,474 (40,988,280) 15 National Electricity Instituto Nacional de Electrificación INDE 2021 9,825,015,940 1,608,012,998 8,217,002,942 2,852,402,719 2,324,874,353 527,528,366 16 National Port Empresa Portuaria Quetzal EPQ 2021 2,728,481,240 313,023,691 2,385,543,071 677,924,133 515,242,283 162,681,851 17 National Port Empresa Portuaria Nacional Santo Tomás De Castilla EMPORNAC 2021 1,449,459,298 536,239,966 913,219,432 787,076,280 705,675,113 81,401,167 18 National Port Empresa portuaria nacional de champerico EPNCH 2021 357,121,380 11,416 357,109,964 6,487,765 5,354,764 1,133,001 19 National Empresa guatemalteca de telecomunicaciones Telecomunication GUATEL 2021 126,608,795 35,262,736 91,346,059 19,862,246 23,877,989 (4,015,743) 20 National Commerce Zona libre de industria y comercio santo tomás de castillaZOLIC 2021 98,199,337 64,680,406 33,518,931 32,756,239 29,462,996 3,293,243 21 National Transport Empresa ferrocarriles de Guatemala FEGUA 2019 73,762,381 29,182,179 53,362,995 24,045,072 20,482,974 3,562,099 22 National Commerce Instituto nacional de comercialización agricola INDECA 2021 67,426,559 6,281,491 61,145,068 13,319,441 11,263,159 (2,056,282) Financial Public Corporations 2,396,719,958 484,475,859 1,912,244,099 305,364,229 45,443,734 251,551,833 23 National Banking El Crédito Hipotecario Nacional de Guatemala CHG 2021 30,906,447 1,074,568 29,831,879 6,080,691 (4,184,331) 1,896,360 24 National Instituto de Fomento de Hipotecas Aseguradas Finance, Non-monetary FHA 2022 2,365,813,323 482,061,713 1,883,751,610 299283538 49611821 249671717 25 National Corporación Financiera Nacional Finance, Non-monetary CORFINA 2022 188 1,339,578 (1,339,390) - 16,244 (16,244) Total Public Corporations 17,122,794,888 3,077,170,742 14,024,492,562 5,851,072,319 4,854,499,839 984,091,254 As Percentage of 2021 GDP 2.33 0.42 1.91 0.79 0.66 0.13 70 Source: MFP and audited financials for each respec ve public corpora on, GDP from BANGUAT Figure 38. Shares in public corpora ons as a Figure 39. SOE revenue distribu on, 2021 (GTQ percentage of total assets, 2021 millions) Source: MFP and Audited financials for each respec ve public corpora on 173. Nonfinancial public corporations represent 57 percent of all SOEs in Guatemala.Error! Reference source not found.103 Of these, INDE, Ports EPQ, EMPORANC, and FHA generate the most in revenue (Figure 39). In 2022, the largest losses were reported by the 14 municipal SOEs (combined), followed by the Guatemalan Telecommunication Enterprise (Empresa Guatemalteca de Telecomunicaciones), the National Institute for Agricultural Distribution (Instituto Nacional de Comercialización Agrícola), and the National Financial Corporation (Corporación Financiera Nacional). However, the largest losses still amount to less than 0.5 percent of GDP. 174. Guatemala has no overarching legal framework for SOEs. The general regulations on national SOEs include an organic law for each entity104 that establishes its functional autonomy as a self- financing enterprise with its own equity, its own legal identity, and the capacity to contract its own obligations. In the case of the largest SOE, INDE, the board of directors consists of representatives from the Ministry of Energy and Mines, the Ministry of Economy, SEGEPLAN, the National Association of Municipalities, business associations, and representatives of trade unions in different parts of the country. INDE also benefits from subsidies to offset social tariffs for electricity, as well as an outstanding guarantee from the government linked to a loan from a multilateral development bank. 175. The government can transfer funds to each of the national SOEs. The transfer takes place once the SOE has submitted a request and that request has been accepted by the Executive and published via government agreement (acuerdo gubernativo).105 While the Directorate for Public Credit (Dirección de Credito Publico, DCP) reviews the loan- and grant-related activities of SOEs (e.g., INDE’s outstanding guarantees), it is not required to comment on budget transfers from the government. On the government side, these funds are classified as current transfers for the provision of services on behalf of the state. For example, INDE has requested an increase in its transfer amount each year and has submitted these requests to the government to be included in the draft budget. The transfer 103 Note that the current list does not include Municipal SOEs. Currently the disaggregated data on these entities is not publicly available in the form of audited financials. It is however accessed via SICOIN database by Minfin officials. 104 For INDE as an example, see the organic law of the national electrification institute, decree no. 64-93 and its reforms ( ley orgánica del instituto nacional de electrificación, decreto no 64-93 y sus reformas ) 105 This process is outlined in Article 44 of Chapter III “On the budget of decentralized and autonomous entities” of the government agreement 540-2013. See: https://www.contraloria.gob.gt/wp-content/uploads/2018/02/9-REGLAMENTO-LEY- ORGANICA-DEL-PRESUPUESTO-ACUERDO-GUB-540-2013.pdf 71 amount is approved through an acuerdo gubernativo106 published by the MPF. Table 12 provides a list of disbursed transfers to select SOEs. INDE has received the largest amount in transfers, with extraordinary transfers in 2020 and 2021 to offset the cost of social tariffs amid the COVID-19 crisis. 176. Transparency and accountability are greater for national SOEs than for municipal ones. All national nonfinancial and financial SOEs publish their internal and external audited balance sheets and financial statements online and undergo audits by the CGC. Public corporations have their budgets approved individually through their own governing structures, and these budgets are forwarded to the Executive and Congress for information purposes. Only the public nonfinancial corporations present their accounts to the CGC. The public financial corporations are supervised by the Superintendency of Banks (Superintendencia de Bancos). The municipal SOEs do not provide any publicly available financial statements but are audited by the CGC. Table 12. Government transfers granted to na onal non-financial public companies 2018-2021 (GTQ millions) 2018 2019 2020 2021 Applicable Disbursed Applicable Disbursed Applicable Disbursed Applicable Disbursed Total Current Transfers 331.8 326.6 40.4 40.0 670.6 667.9 665.7 382.8 Empresa guatemalteca de telecomunicaciones (GUATEL) 1.5 1.5 - - Empresa portuaria nacional de Champerico (EPNC) 4.8 4.8 4.6 4.6 4.6 4.6 5.6 5.6 Ferrocarriles de Guatemala (FEGUA) 8.4 8.4 20.8 20.6 20.9 19.7 17.1 4.2 Instituto nacional de comercializacion agricola 17.1 11.9 15.0 14.7 15.0 13.6 13.0 13.0 Instituto nacional de electrificacion (INDE) 300.0 300.0 - - 630.0 630.0 630.0 360.0 177. The MFP provides an important oversight function, especially for municipal SOEs, but greater accountability is needed. The MFP website provides consolidated financial statements for the national and municipal SOEs that are entered into the System of Integrated Accounting (SICOIN). While the fiscal risk report includes a basic profitability analysis for the SOE sector and the individual entities, the MFP does not yet provide a consolidated report on the sector or a breakdown of balance- sheet and income-statement line items by entity. Other than for the purposes of the annual fiscal risk report, for which the respective teams update SOE-related data, the consolidation of the nonfinancial public sector accounts is performed monthly with data from SICOIN. No quality-control checks are performed on the data submitted by the entities to SICOIN, and there is not yet a unit within the MFP dedicated to monitoring SOEs. d) Municipali es 178. Municipalities are a source of implicit contingent liabilities, with non-guaranteed debt estimated at less than 1 percent of GDP. There are 22 departments and 340 municipalities in Guatemala. Non-guaranteed financing liabilities from municipalities were estimated at 0.3 percent of GDP as of end-2021 (Table 13). A few municipalities present a large volume of liabilities relative to their nonfinancial revenue. At end-2021, four municipalities had liabilities exceeding half of their annual nonfinancial revenue: San Miguel Potucha (77.3 percent), Guatemala City (71.9 percent), San Lorenzo (62.5 percent), and Santa Catarina (59.8 percent). Due to its size, Guatemala City represents the most important source of municipal debt risk to the central government. 106Latest agreement for the fiscal year 2022 is published for INDE found under https://www.minfin.gob.gt/images/downloads/leyes_acuerdos/AGUB%20136-2022%20INDE.pdf 72 179. The legal framework limits the issuance of non-guaranteed debt by municipalities. Municipalities have the capacity to contract debt subject to administrative controls. The constitution grants municipalities the power to obtain their own resources, including through debt operations. Loans are approved by the respective municipal councils, as well as by the MFP and the Congress in the case of external financing. However, the Municipal Code, amended in 2010,107 stipulates that municipalities may not contract credit liabilities with repayment periods exceeding the term of office of the leadership of the approving municipal council. Moreover, municipalities must obtain opinions from the executive body and the Monetary Board to issue, negotiate, and place securities domestically or abroad. Therefore, municipal debt that is not guaranteed by the central government has consisted primarily of short-term loan operations with domestic banks. Table 13. Financial liabili es and non-guaranteed debt from municipali es (% of revenues and % of GDP) Variable 2016 2017 2018 2019 2020 2021 Municipal financial liabilities as a 18.7 18.4 16.7 12.2 14.9 13.7 share of total revenues Of which: non-guaranteed debt 12.3 11.3 9.9 6.0 8.2 8.0 Municipal financial liabilities as a 0.42 0.42 0.38 0.29 0.33 0.32 share of GDP 180. Municipalities can also contract debt through the Municipal Development Institute ( Instituto de Fomento Municipal, INFOM). INFOM is an autonomous government entity that provides technical and administrative assistance and financial support to municipalities. It offers loans to help council governments improve their municipal services by building, expanding, or improving infrastructure. It also serves as an intermediary between municipalities and domestic banks in the process of contracting loans. Risks are mitigated by the legal framework, as these loans require an inter- institutional agreement for INFOM to use specific budget lines as guarantees. INFOM, when acting as an intermediary, provides financial institutions with information about the repayment capacity of municipalities. 181. The MFP oversees local governments’ finances via the Municipal Financial Management Index. The Directorate of Assistance to Municipal Financial Administration ( Dirección de Asistencia a la Administración Financiera Municipal) supports the preparation of the Municipal Management Ranking, coordinated by SEGEPLAN, and develops the Municipal Financial Management Index. 108 The index consists of seven indicators: (i) municipal financial autonomy; (ii) own-source income per inhabitant excluding royalties; (iii) property tax income in relation to own-source income excluding royalties; (iv) investment in fixed capital per inhabitant; (v) investment in fixed capital with resources received from own-source income; (vi) investment in fixed capital with resources received through transfers from the central government; and (vii) financial independence in terms of public debt. The index measures the efficiency with which financial resources are utilized. The benchmarks for each of the seven indicators are defined based on national best practices. 182. The monitoring of municipal finances can be further integrated into the fiscal risk framework. While some indicators, such as financial autonomy, are included in the fiscal risk report, the index 107Reforms to the Municipal Code Decree 12-2002. Article 30. 108DAAFIN (2018). Guide for the Elaboration of the Municipal Financial Management Index. See the results by municipality https://bi.minfin.gob.gt/BOE/OpenDocument/2204090841/OpenDocument/opendoc/openDocument.faces?logonSuccessful=tr ue&shareId=0 73 could more effectively quantify and manage fiscal risks related to municipalities. Implicit contingent liabilities arising from municipalities are not yet quantified beyond the inclusion of the total amount of non-guaranteed municipal debt. There are no formal explicit limits on non-guaranteed municipal debt based on their own repayment capacity. 183. The legal framework establishes reporting rules for municipalities, but transparency could be improved. The municipalities are required to report through the SIAF debt module the details of current domestic and external loans, as well as the balance of contracted debt to the MFP, within ten days of the end of each month. DAAFIN monitors this information. However, no information on municipal debt is made publicly available. 3. Fiscal risks from natural disasters 184. Guatemala is highly exposed to multiple hazards. In the 2021 Global Climate Risk Index (CRI), Guatemala ranked 16th out of 180 countries109 in terms of exposure to climate hazards. The CRI considers the extent to which countries have been affected by weather-related events, including human costs and economic losses. Guatemala’s vulnerability to extreme climate events threatens its fiscal and economic stability. 185. Historically, disasters have inflicted significant damages and losses in Guatemala. According to post-disaster needs assessments, the 1976 earthquake caused damage and losses equivalent to 20.7 percent of GDP. More recent events, such as Hurricane Mitch in 1998, Hurricane Stan in 2005, and the combined effect of Tropical Storm Agatha and the eruption of the Pacaya volcano, caused damages and losses equivalent to 12.2 percent of GDP (Figure 40). Historical damages represent around 4.22 percent of GDP.110 The Global Facility for Disaster Reduction and Recovery estimates that the annual average loss from earthquakes and hurricane represents a combined US$347 million (0.5 percent of GDP), which can reach a probable maximum loss of US$8,522 million per year (12 percent of GDP) ( 186. 187. Table 14). Figure 40. Damage and Losses Caused by Severe Events, 1975-2015 109 The report can be found at https://www.germanwatch.org/en/19777. It considers how Guatemala ranks among 180 countries considering average losses in US$ million (PPP) and per unit of GDP for the period 2000-2019. 110 This estimate is based on average damages (US$) of natural disasters in Guatemala from 1976 to 2022 extracted from EM- DAT database, using IMF WEO nominal GDP time series. 74 Table 14. Disaster risk profile for Guatemala Earthquakes Hurricanes Annual average loss US$ millions 325.3 21.6 Percent of GDP 0.46 0.04 Probable Maximum Loss US$ millions 7,900 622 Percent of GDP 11.2 1 188. The MFP has assumed a more active role of managing fiscal risks emanating from natural disasters. Disaster risk management combines elements of fiscal resilience and climate adaptation, reflecting Guatemala’s high vulnerability to natural hazards. The fiscal risk report published with the budget documents describes the frequency and characteristics of the disasters observed. 189. The latest fiscal risk report for 2024-2028111 deepens its analysis of fiscal risks related to disasters. The report provides information on the projected fiscal impact that natural hazards have had on the fiscal profile and provides projections of fiscal impacts by type of disaster. For example, a hurricane is projected to increase the annual fiscal deficit by 0.2 percent of GDP, while an earthquake is projected to increase the deficit by 1.1 percent of GDP, and a volcanic eruption is projected to have a minimal effect. These estimations consider expenditures and foregone revenues and are for the year in which the disaster occurs. The exercise could be improved by specifying an estimated probability for each disaster type. Future estimations should also cover the impact on implicit and explicit contingent liabilities. Table 15. Summary of scenarios by disaster type 2023 2024 2025 2026 2027 2028 Storm or Hurricane Damage of 2.3% with respect to GDP Growth 3.5 2.1 2.6 2.7 2.7 2.7 Deficit (% of GDP) 1.7 1.9 1.5 0.9 0.4 0.0 Debt (% of GDP) 28.4 28.2 28.1 27.4 26.1 24.5 Earthquake Damage of 9.3% with respect to GDP Growth 3.5 0.7 2.7 2.8 2.8 2.8 Deficit (% of GDP) 1.7 2.8 2.3 1.1 0.6 0.2 Debt (% of GDP) 28.4 29.6 30.3 29.7 28.6 27.2 Volcano Damage of 0.3% with respect to GDP Growth 3.5 2.4 2.6 2.7 2.7 2.7 Deficit (% of GDP) 1.7 1.8 1.3 0.8 0.3 -0.1 Debt (% of GDP) 28.4 27.9 27.6 26.7 25.4 23.8 190. Complementing the fiscal risk report, the MFP has elaborated its own financing strategy for disaster risk. The strategy was published 2018112 and approved by Ministerial Agreement 206-2018. It outlines the strategic framework under which the government monitors, estimates, manages, and 111https://www.minfin.gob.gt/images/archivos/estadisticas2/estudios_fiscales/Informe%20de%20Riesgos%20Fiscal%20070920 23.pdf 112 “Estrategia Financiera ante el Riesgo de Desastres.” https://www.minfin.gob.gt/images/estrategia_financiera.pdf 75 evaluates ongoing fiscal risks from natural hazards. In 2022, a follow-up document was published presenting the operation plan for the approved strategy113 under Ministerial Agreement 167-2022. The document consolidates the actions for each strategic line during 2022-24, and it defines the implementation horizon and responsible entities. 191. Three other government entities complement the institutional framework for disaster risk management. CONRED databases monitor the frequency and intensity of natural hazards. SEGEPLAN manages institutional coordination between local governments, ministries, and institutions. It also participates in the processes of incorporating risk management into public investment projects and expenditures and in the implementation of agile mechanisms for completing post-disaster needs assessments. SEGEPLAN recently published the Report on Losses and Damages from Climate Change in Guatemala.114 192. Guatemala currently has two funds to finance the response to natural disasters. The National Permanent Fund for Disaster Reduction (Fondo Nacional Permanente de Reducción de Desastres) was created in 1996 to finance disaster prevention, mitigation, preparedness, response, and recovery, as well as to support CONRED’s activities. It is funded on an annual basis by resources from the national budget. The Emergency Fund (Fondo Emergente) was created by a government agreement in 2012. Its aim is to mitigate the damage that may be caused by natural phenomena. It is a cumulative fund financed by voluntary contributions from mining companies. 193. The MFP manages the contracting of financial instruments to manage the risk of natural disasters. The MFP has arranged contingent loans with the Inter-American Development Bank for up to US$400 million and with the World Bank for up to US$190 million to address emergencies arising from natural Since 2019, Guatemala has been part of the Caribbean Catastrophe Risk Insurance Facility (CCRIF). Parametric excess rainfall insurance was taken out during 2019-2020 and renewed during 2022-2023. The policy covers rainfall events and provides maximum coverage of up to US$7.2 million. To date, no insurance has been taken out against other types of natural disasters. D. Recommenda ons for Strengthening the Management of Fiscal Risks 194. The management of fiscal risks in Guatemala could be improved by revising the legal framework and strengthening current practices. Guatemala has made significant progress in analyzing and managing fiscal risks, and the coverage of its fiscal risk report has steadily expanded. However, current practices are not defined in the legal framework. The law needs to reflect a definition of fiscal risk that will provide the basis for a comprehensive monitoring and reporting framework. Publishing a comprehensive fiscal risk statement will enable the government to better manage contingent risks, thereby protecting its fiscal projections and reinforcing the sustainability of the public finances. 195. Once the main risks are identified, the next steps are to quantify them and estimate their probability of materializing. Expanding the coverage and depth of fiscal risk analysis should be complemented by institutional strengthening to improve comprehensive fiscal risk management. A more complete picture of the government’s risk exposure can be obtained by including quantitative and probabilistic analyses of the materialization of these risks in the fiscal risk report. 113 Estrategia Financiera ante el Riesgo de Desastres: Plan Operativo, https://www.minfin.gob.gt/images/downloads/minfin2022/167-2022mfp.pdf 114 Informe de Pérdidas y Daños por Efectos del Cambio Climático en Guatemala, SEGEPLAN 2021, Accesible under https://portal.SEGEPLAN.gob.gt/SEGEPLAN/wp-content/uploads/2023/08/Informe_Guatemala2021_CC.pdf 76 196. The government should develop procedures, capacity, and tools for assessing credit risk and for monitoring and controlling the granting of loan guarantees. This is particularly important for the disbursement of loans and the extension of guarantees to SOEs and municipalities. Credit risk assessments can guide the level of disbursements to each SOE as well as the assigned cost to each unit. Entities with stronger financial profiles would be assessed as having lower credit risk, all else being equal, which would influence the amount and the terms of disbursements by the government. The content and structure of the evaluation can inform the SOE’s credit risk report, and its rating can be made public in the fiscal risk report. 197. Several reforms could enable the government to better forecast and mitigate fiscal risks arising from loan guarantees. These include:  Adding a provision to the budget to identify potential guarantee calls and specify how to provision for them if the SOE cannot cover them in full. Ideally, the provision should reflect the perceived risk to each SOE.  Applying a risk premium on the issuance of guarantees based on credit risk assessment and imposing penalties and sanctions in case of late payments.  Defining a cost-recovery framework for guarantees.  Specifying a loan guarantee ceiling in the public debt management strategy, monitoring the stock of guarantees to ensure it is within the ceiling, and facilitating guarantee issuance where it is most beneficial or less risky for the government. 198. The fiscal risk report should include a section on PPPs. As new PPP projects are approved, it will be important to establish mechanisms and methodologies to manage the risks arising from explicit contingencies by introducing mechanisms to limit accumulated project expenses. One option to consider is to define a ceiling for the maximum stock of explicit contingencies and create a framework to quantify explicit contingencies from PPPs, along with their probability of materializing. 199. The government should institutionalize SOE credit risk assessments. There is a limited framework for establishing a formal assessment standard that would allow for comparisons of credit risk across SOEs. Creating such a framework would facilitate risk assessments conducted during the process of funding requests to DCP and the Executive agencies. Risk assessments would enable the allocation of greater funding to lower-risk entities and allow for risk sharing when funds are allocated to entities with higher identified credit risk. This function could be assigned to a unit within the MFP, such as the DCP, which would be responsible for developing a credit risk assessment methodology, along with relevant skills and tools. Establishing a coordination mechanism with the unit in charge of the fiscal risk report would ensure that adequate financial data are provided by SOEs and that risk assessments are shared across units that work with the financials of SOEs. 200. Currently, only national SOE annual reports are disclosed publicly. Producing and publishing the annual audited reports of the largest and most strategically important municipal SOEs on the website of the enterprise or of the MFP on a regular and timely basis would enhance transparency. These reports should provide detailed financial and analytical information and should be complemented by the publication of the financial statements of national SOEs in line with best practices for financial transparency. 201. A system for monitoring municipal finances is in place, but it does not inform decisions around fiscal risks. Monitoring municipal finances is an effective way to mitigate financial stress at the local 77 level. The government should strengthen the monitoring of municipal finances by using data from the Municipal Financial Management Index to quantify implicit contingent liabilities, estimate their probability of occurrence, and create an early warning system for municipal-level fiscal risks. The application of formal and explicit limits on municipal non-guaranteed debt should be estimated based on the repayment capacity of each municipality. 202. Strengthen financial disclosure and transparency around debt-related transactions. As with SOEs, information on non-guaranteed debt should be published in the annual debt bulletins and/or statistics. In line with international best practices, the published information should include creditors and beneficiaries, signing dates and maturities, outstanding amounts, and other key data. 203. While Guatemala takes a proactive approach to managing the fiscal risk emanating from natural disasters, there is room for improvement. Key options include:  Regularly conducting and publishing analyses that evaluate the magnitude of budgetary expenditures on natural disasters.  Clearly identifying the sources of financing for new climate-related expenditures.  Quantifying the explicit and implicit contingent liabilities arising from natural disasters.  Evaluating the sufficiency of the resources currently allocated to deal with disasters. Table 16. Summary of recommenda ons Legal and Institutional Framework  Establish a comprehensive legal and institutional framework to estimate, manage, and report fiscal risks and implement risk-mitigation and monitoring mechanisms.  Clearly define fiscal risks in the legislation and assign responsibilities for managing them across ministries and agencies. Specific risks Guarantees  Develop procedures, institutional capacity, and tools for assessing credit risk.  Monitor and control the disbursement of loan guarantees and on-lending, specifically to SOEs and municipalities, based on credit risk and differing fee and cost structures. Include this evaluation in the fiscal risk report PPPs As new PPP projects are approved, create mechanisms and methodologies to limit and manage risks arising from explicit contingencies:  Introduce mechanisms to limit accumulated expenses associated with the projects, possibly by defining a ceiling for the maximum stock of explicit contingencies.  Use the framework to quantify explicit contingencies from PPPs and their probability of materializing.  Include a section on PPPs in the fiscal risk report. SOEs  Institutionalize SOE credit risk assessments that enable comparability across entities during the process of submitting funding requests to DCP and the Executive agencies. Allocate larger amounts of funding to lower- risk entities and establish risk-sharing mechanisms for entities with higher risks.  Strengthen financial disclosure and transparency by producing annual audited reports for the largest and most strategically important municipal SOEs and publishing them on the website of the enterprise or of the MFP on a regular and timely basis. Municipalities  Use data from the Municipal Financial Management Index to quantify implicit contingent liabilities and estimate their probability of materializing. 78  Use the results to create an early warning system for implicit contingent liabilities from municipalities.  Evaluate the application of formal and explicit limits on the non-guaranteed debt of municipalities based on their own repayment capacity.  Strengthen financial disclosure and transparency. Climate/Disasters  Regularly conduct and publish analyses that evaluate the magnitude of budgetary expenditures for natural disasters.  Clearly identify the sources of financing for new climate-related expenditures,  Estimate the frequency of events for which it has been necessary to increase budget allocations beyond what was initially programmed. 79 VI. References Agencia Nacional de Alianzas para el Desarrollo de Infraestructura Económica. (n.d.). Informes ANADIE - Memorias de Labores 2022. Retrieved from ANADIE: h ps://anadie.gob.gt/informes/ Asatryan, Z., Bi schi, B., & Doerrenberg, P. (2017). Remi ances and public finance: evidence from oil- price shocks. Journal of Public Economics(155), 122-137. Bachas, P., & Soto, M. (2021). Corporate Taxa on under Weaker Enforcement. American Economic Journal: Economic Policy, 13(4), 36-71. Bachas, P., Brockmeyer, A., Dom, R., & Semelet, C. (2023). Effec ve Tax Rates and Firm Size. World Bank Working Paper Series(10312). 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