Tax Reform Called Key to Mexico Growth

The Mexican government Friday stepped up its lobbying for a radical tax reform program, certainly one of President Vicente Fox’s toughest political battles and critical to his prospects for transforming the Mexican economy.

Finance Minister Francisco Gil Diaz addressed just one topic in his address to the annual Mexican bankers’ convention: tax reform. He said the financial reform bill, to be submitted to Congress on Tuesday, would “lay down a solid base to consolidate stability and promote rapid, sustainable economic growth.”

The most controversial aspect of the package is the repeal of an exemption for food and medicine from the national 15% value-added tax, which would not only raise billions of extra dollars but also expose Fox to withering political assault.

Gil made what is likely to become the government’s key defense of the measure: The current exemption benefits the top 40% of earners and not the poorest Mexicans, many of whom receive free government medicines. He said those in the bottom 20% of the income ladder receive just 3% of the benefit of the tax exemption.

To offset the effect of the additional value-added taxes on the poor, Gil said the government would exempt the first 50,000 pesos (about $5,250) in earnings from federal income tax and exempt a basket of basic generic medicines from the value-added tax.

Fox’s own center-right party, the National Action Party, is expected to back the reform, but the center-left Party of the Democratic Revolution already rejects the proposal. That will leave the power balance to the centrist Institutional Revolutionary Party, or PRI, which lost the presidency to Fox last year for the first time in 71 years. In the past, Fox’s party and the PRI have aligned on budget votes, and Fox is hoping to lure enough PRI support to get the measure approved.

Opening the banking convention Thursday night, Fox himself stressed the importance of the tax legislation, which along with his Chiapas peace effort is by far the highest-profile initiative of his administration.

The president noted that Mexico collects less than 11% of its gross domestic product in tax revenue each year, well below other Latin American countries, and he said just 42 centavos of each peso spent by the government are financed from the principal taxes. The nation’s weak tax collection system leaves it heavily dependent on taxes from sales of crude oil, a risky and volatile commodity.

The government has said the package would raise overall tax collection to more than 13% of GDP.

Anticipating the political firestorm ahead, Fox framed the tax reform debate as one of fairness for the poorest Mexicans.

“The purpose is to take resources from those who can pay and not affect the income of those who find themselves in the worst of miseries,” he said. “The poor are not going to pay for this reform, they are going to receive more than they have today.”

He said 5 million poor families would benefit from the restructuring of the tax system and from increases in poverty programs to compensate for the loss in food and medicine exemptions.

However, some academics and political opponents have responded that raising taxes on food and medicine would have a devastating effect on the middle class and working poor, who would not benefit from the other breaks. Experts are furiously debating how the many variations expected to be considered by Congress in coming weeks would affect different sectors of Mexican society.

Without entering into details, Fox emphasized the critical need for stronger, more reliable tax flows. Without them, Fox said, “we cannot cover healthily the sum of public obligations, lower interest rates, reactivate credit and carry out social programs and address the backlogs that all of Mexico demands.”

The tax reform package also is expected to include provisions to simplify tax codes, reduce the top personal income tax rate to 32% from 40% and raise the corporate income tax ceiling to 32% from 30%.

Fox won a solid endorsement from the bankers’ association. Its president, Hector Rangel, said: “This is the moment to realize the structural reforms that the nation needs. For years, basic reforms have been postponed, such as fiscal reform that should end the endemic scarcity of state resources and reduce the excessive dependence on petroleum.”

He said failing to adopt fiscal reform would have immediate negative effects in financial markets. Analysts have said successful tax reform would open the door to an investment-grade rating for Mexico from Standard & Poor’s. That rating, along with the one granted last year by Moody’s, would allow U.S. and other foreign investment funds to pour into Mexico.

That in turn would help make business finance more affordable and help revive banking credit that has been stagnant since the mid-1990s peso crisis.