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Fiscal Reform in Mexico

Latin America Advisor

Officials in the government of Mexican President Felipe Calderon are hopeful the country's Congress will approve fiscal reform by September. Do you think Congress will pass the reform? What needs to be done to make the Mexican government fiscally healthy?

Juan Carlos Moreno-Brid, Senior Economic Affairs Officer at the United Nations' Economic Commission for Latin America and the Caribbean: Mexico's fiscal performance has fundamental weaknesses that must be corrected, indeed. First of all, its tax revenues—excluding oil—are extremely small. They need to increase, say, at least five points of GDP to be able to provide the public services and basic infrastructure that a modern society requires. Second, approximately one-third of fiscal income is derived from oil revenues that are highly volatile and likely bound to significantly decrease in the medium term unless substantial investment in exploration and extraction is carried out. Moreover, this dependence is due to a rather distorted tax scheme imposed on Pemex that, in practice, makes it very difficult for it to invest and become more efficient. Third, such weak fiscal revenues are partly the consequence of numerous tax exemptions, endemic tax evasion, and an explosion of the informal sector. In addition, taxation of capital gains is more the exception than the rule. Fourth, the conventionally measured fiscal deficit is low, but does not register certain disbursements—so-called contingent liabilities—that have grown massively in recent years, inter alia social security pensions. Finally, its zero-deficit rule has a pro-cyclical element imbedded in the fiscal budget process, so that fiscal policy tends to exacerbate business fluctuations. These are all major shortcomings. But one thing is recognizing them, and another—very different one—is being able to solve them. For this, it is necessary to build a 'fiscal pact' between the government, civil society, and the entrepreneurial sector which recognizes that for Mexico to enter a path of development with social inclusion it needs substantially higher fiscal revenues. These will have to be used in a transparent and socially accountable way to improve the quality and quantity of public goods.

Rogelio Ramirez de la O, Director General of Ecanal in Mexico and a former economic advisor to ex-Mexican presidential candidate Andres Manuel Lopez Obrador: With the PRI leadership in Congress willing to negotiate almost anything in exchange for positions of power, and with the government willing to pay for them, indeed it is possible that the tax reform which the government wants will be approved this year. But because of the controversial nature of what the government wants (to tax consumption either with a VAT on food and medicine or with an exempt rate—the latter preventing the ultimate seller from receiving credit for VAT paid, therefore forcing him to raise prices), I am afraid the PRI will ask a high political price, even higher than what it obtained for pension reform. This will not make the fiscal system healthy, though. For the past six years VAT revenue has performed well (up 61 percent in real terms, 2000-2006). Income tax performed less well or badly (up 37 percent in the same period). The system is designed for the two pillars (consumption and income taxes) to rise well above income growth, not for VAT to rise and income tax to lag behind. The system will not be healthy until the government decides to tax the 100 top companies, most of which perform like cartels. In fact, this is what the reform should be this year in order to keep VAT for another time, if and only if the government builds up political capital. Otherwise, it will not raise enough and will lose the little support it has built with the lower and middle classes.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter. 

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