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Fiscal Reform Will Hurt Mexico

President Felipe Calderon's proposed fiscal reform will hurt -- rather than help -- Mexico's economy, experts say.

Inter-American Dialogue 

Mexican President Felipe Calderon on Sept. 8 released his fiscal reform proposal, which includes a new 2 percent tax on all goods and services including medicine and food. What effect would the new tax have on Mexico's economy, which is mired in its worst recession since the 1930s? Would the move help lessen Mexico's dependence on oil revenue, as its advocates hope? What are Calderon's chances of getting his plan through Mexico's Congress?

Rogelio Ramírez de la O, director of Ecanal in Mexico City: The tax proposed by the Calderon administration is ill-suited for Mexico's economy, as more consumption taxes (not only the 2 percent sales tax, but also the 4 percent tax on telecommunications and special taxes on selected products) will further depress consumption when the economy has fallen 9 percent during the first semester. Now, considering that the government is also hiking public sector prices beginning with gasoline and electricity, the effect would be a mixture of further recession with more inflation. In this crisis unemployment has risen sharply, adding around 1 million people on an annual basis between unemployed and under-employed, which suggests that social effects will be deleterious. Ironically, the package will not deliver more than 1 percent of GDP in additional revenue (although the government expects close to 2 percent) considering that consumers will resort to the ever-expanding underground economy, while businesses shed more workers and continue to record losses or poor profits, apart from the monopolies. Thus the fiscal gap will remain in place, exceeding by four times the potential increase in revenue. Were revenue to rise more than 1 percent of GDP, Mexico would be the only country in the world increasing tax revenue while the economy plummets. As a reminder, the tax 'reform' of 2007 introducing IETU was projected to increase revenue by 2 percent of GDP, but in practice it increased it only by 0.5 percent with the economy still growing. The chances of the Congress approving it are slim, but not nil, for there has been previous negotiation with the leadership of the PRI, in exchange for more revenue for state governments. The outcome would still be a diluted package which will serve, however, to navigate for a few months before the next crisis.

Andrew Selee, director of the Mexico Institute at the Woodrow Wilson International Center for Scholars in Washington: President Calderon's fiscal package is certain to meet resistance in Congress. Raising taxes is never popular anywhere in the world, and it is even less so in the middle of an economic crisis. The package also touches key economic interests in the country that are already struggling under the weight of the recession, and it forces politicians to go on record approving taxes right when the economic pain is worst for most Mexicans. The underlying idea, of course, is a good one: it is unsustainable for the Mexican state to continue to depend on oil revenues for more than a third of its public budget. Most politicians recognize, at least rhetorically, that Mexico needs to raise new taxes that bring the country more in line with the average fiscal burden elsewhere in the region. There also need to be provisions for investing excess oil revenue in good years to renew Pemex's infrastructure and to create an ambitious counter-cyclical development fund, in the way that Chile has done with copper and nitrate revenues. However, it seems likely that a major opportunity was missed when oil revenues were high and the economy was expanding. Now it will be hard to get much of what President Calderon has recommended, regardless of the long-term economic sense of finding ways to raise fiscal revenues.

Roderic Ai Camp, professor of government at Claremont McKenna College in California: The decision to revisit the issue of a tax on food and medicine is an attempt by the Calderon administration to increase tax revenues, which always have been historically low in Mexico. While one could make the argument that any tax revenue would contribute to lessening Mexico's dependence on oil revenues, which rarely have been saved for rainy day economic downturns, to my mind this is a highly regressive tax on essential consumption, especially when you consider that 40 to 45 percent of the population lives in poverty ($2 or less per capita per day). Moreover, it is clear that large numbers of Mexicans who were able to escape poverty in recent years have returned to that status as a result of the severe economic recession. What the government really needs to address in its fiscal policy is increased taxes on middle and higher incomes. Further, as a leading PRI senator suggested to me months after Calderon took office, it also needs to address monopolies, which are preventing competition in numerous economic sectors. The proposed tax plan is essentially the same, only at a lower rate of 2 percent, as a bill proposed earlier in Calderon's administration. It is extremely doubtful that the Calderon administration will obtain the necessary bipartisan support from the PRI to achieve passage of such a bill in Congress. The PRI is positioning itself for a successful presidential race in 2012; therefore, it does not want to support a controversial piece of legislation. While it also does not want the public to view it as obstructionist, as was the case after its congressional victory in the 2003-2006 session, it has no need to take any serious political risks. 

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


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