Sure Things in Mexico: Death, Taxes and Evasion

High taxes might be weighing on the California economy, but Mexico is proving that a low tax take could be worse.

Tax collection in this country is meager, and it’s sinking the nation’s competitiveness. Mexico, though the world’s 10th-largest economy, ranks with Sri Lanka and Ethiopia when it comes to generating revenue to pay for public services.

Distrust of the government runs so deep, and the untaxed underground economy is so vast, that by some estimates as much as half of Mexico’s potential tax take is lost to evasion. In fact, if not for royalties and pump taxes from state-owned oil monopoly Pemex, which fund nearly one-third of the $150 billion in annual federal spending, Mexico’s fiscal house would collapse.

The government tried emotional appeals this year to get people to pay, placing newspaper ads showing smiling tots and the disabled urging taxpayers to “keep helping Mexico” by filing their returns by the April 30 deadline.

“People aren’t stupid,” said Rogelio Ramirez de la O, a Mexico City economist. “They’re very dubious about where that money is going.”

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Holes in the Treasury

The country is paying dearly for its citizens’ perpetual tax holiday. While up-and-comers like China are throwing billions of dollars into advanced research, superhighways and high-technology parks, Mexico’s tax haul can’t cover basics like schoolbooks, cops and sewers.

Just-released rankings of global competitiveness put out by IMD International, the Switzerland-based International Institute for Management Development, placed Mexico at 56 out of 60 economies examined, largely because of a dearth of investment in everything from potable water to ports. Only Poland, Indonesia, Argentina and Venezuela ranked lower.

“Essentially you’ve got a country that isn’t spending enough on fundamentals like education and healthcare that are essential to economic growth, much less the infrastructure development that leads to more competitiveness,” said Jorge Martinez-Vazquez, an economics professor at Georgia State University and an expert on the Mexican tax system. “Mexico provides a clear example of what happens in an economy when there is a consistent failure to raise the tax effort.”

Martinez-Vazquez said Mexico’s tax rates and structure generally were in line with those of other major economies. For example, its top income tax bracket in 2003 was 34%, compared with the top U.S. rate of 35%. But Mexico’s collection rate is abysmal.

According to the World Bank, Mexico’s tax revenue has generally ranged from 12% to 15% of its gross domestic product over the last couple of decades. The latest figures from IMD International put Mexico’s total tax collection somewhat higher, about 17.8% of GDP in 2002. By comparison, IMD said, the U.S. collection rate amounted to 28.6% of its GDP in 2002, while some European nations are north of 40%. Analysts said Mexico’s percentage drops to single digits when oil revenue is discounted, putting its tax collectors among the most inept on the planet.

Experts point to a variety of factors to explain the lousy showing, including Mexico’s exploding underground economy, complicated tax laws and weak enforcement. The system has long burdened the small middle class while offering breaks to businesses and the rich. But many say the heart of the problem lies in decades of government corruption that has sapped Mexicans’ willingness to pay.

A poll of 17 Latin American countries last year by Chile-based Corporacion Latinobarometro showed that 9% of Mexicans surveyed believed that their taxes were well-spent. The only respondents more pessimistic were residents of Ecuador, where unrest over entrenched poverty and government thievery led to a military coup in 2000.

To be sure, Americans aren’t exactly enamored of paying taxes, and there is plenty of government waste and fraud in the United States. Still, transparency laws, public audits and local control over many forms of taxation mean that basic services are paid for and delivered.

In contrast, Mexico’s tax system is highly centralized, with the federal government collecting most of the revenue, then distributing it back to the states.

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Paying Up, Reluctantly

Christian Stracke, a Mexico analyst with New York-based research firm CreditSights, said that has fed a murky patronage system that for decades has benefited a few at the expense of millions.

For example, lucrative pensions for federal government workers are devouring the budgets of Mexico’s public health and university systems. Meanwhile, 1 in 6 Mexicans doesn’t have running water, and about 4 in 5 lack high school diplomas.

“The average guy looks at his tax money going to overpaid, politically connected bureaucrats and wonders why he should support the system,” Stracke said. “It creates this vicious circle, because people don’t want to pay because of the poor quality of services. But the services are bad because there aren’t enough people paying.”

There weren’t many happy faces outside the main office of Servicio de Administracion Tributaria, Mexico’s version of the Internal Revenue Service, late last month as the deadline to file income tax declarations approached.

Waiting in line to procure the services of a sidewalk typist to complete his forms, Jose Luis Elizalde said he felt like a sap for filing a return when nearly half of Mexican workers don’t.

“Of course it bothers me that the guy next to me isn’t paying anything,” said Elizalde, 39, an assistant in an accounting office. “But it would be just my luck to get audited.”

Just ahead of him, Jesus Souto complained that Mexico’s tax-supported health service lacked sufficient medicine and equipment, although he gave President Vicente Fox some credit for trying to restore confidence in the system.

“A society without taxes can’t function,” said Souto, 56, a marketing consultant. “But Fox alone can’t change everything. He arrived with a Congress that doesn’t want to do anything.”

With his National Action Party lacking a majority, Fox has seen his efforts to reform the tax code go nowhere. Apart from royalties from Pemex, Mexico relies on three major revenue sources: income taxes; value-added taxes on goods and services; and so-called special taxes on products such as tobacco, alcohol and fuel.

Fox’s tax plan, put before Congress last year, focused mainly on the value-added tax, known as the IVA in Mexico; the levy is assessed on the increased value of products as they move from raw material to final sale. Essentially, each processor or middleman pays IVA on the amount he or she marks up the goods, while consumers pay it as a sort of sales tax.

The Fox administration had proposed lowering the tax to 10% from 15%, while closing loopholes and levying it on a broader range of goods and services. The most controversial aspect of the plan was to slap the IVA on food and medicine, staples that had previously been tax-free.

Some economists like value-added taxes because they penalize consumption rather than investment. But they also are regressive, hitting lower-income consumers relatively harder than the rich. So even though the Fox plan would have raised the equivalent of $9 billion, it was squelched in December by legislators in rival parties who decried the plan as unfair to the poor.

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True Reform on Hold

Political experts say Mexican tax reform is all but dead for the remainder of Fox’s term, leaving him little to do between now and 2006 except tinker around the edges. The government is making efforts to strengthen enforcement, using electronic tools to search bank records and other financial data to root out cheats. But some worry that such efforts will lead to harassment of existing taxpayers while ignoring the system’s true weakness.

“The problem is growing the number of contributors,” said Jaime Sempere Campello, director of the Center for Economic Studies at Colegio de Mexico. “ ... That’s the reason Mexico doesn’t collect enough to maintain an efficient government.”

One of the most obvious targets is the massive underground economy, which accounts for one-fourth of Mexico’s GDP. It’s estimated that nearly half the workforce is off the books, from day laborers, maids and street vendors who scratch out a living day to day, to lucrative pirating operations that control the lion’s share of Mexico’s music and video distribution.

Trying to legalize all that activity is so daunting and potentially counterproductive that even the experts hardly know where to begin. Efforts by Fox to encourage more legitimate business formation and hiring have borne little fruit. Meanwhile, tax authorities simply don’t have the resources to chase down every corner shoeshine man and chewing gum saleswoman.

Still, economist Ramirez de la O said, Mexico’s underground economy is growing so rapidly that steps must be taken to rein it in. For starters, he said, the government needs to cut the costs, paperwork and delays in starting a legal business, while bureaucrats need to start thinking about what they can offer the shadow entrepreneurs instead of only what they can squeeze out of them.

For example, he said, many of the tens of thousands of itinerant vendors on Mexico City’s streets must pay protection money for their little patches of turf, either to police or to organized crime. He figures that many would gladly pay those same sums to the government if, in return, they could expect a clean, safe place to sell their wares.

“You’ve got illegal vendors selling right in front of the Treasury Ministry,” Ramirez de la O said. “The government has got to reestablish the legitimacy of the state in society.”

Mexico’s reluctance to face up to its taxing situation is now draining its one reliable source of revenue: oil. The government is sucking so much money out of Pemex to fund its own operations that the state-owned company lacks the resources it needs to invest in exploration. At a public meeting this month, Roberto Oseguera Villasenor, director of strategic planning for Pemex, warned that the government was killing its own golden goose.

“It isn’t possible that this situation can continue like this for much longer,” he said, “because if so, the patrimony of Mexico is going to be zero, a technical bankruptcy.”

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Low on the list

Mexico boasts the world’s 10th-largest economy. But it is a laggard when it comes to tax collection.

Tax revenue as a percentage of gross domestic product in 2002 for the largest economies

*--* France 44.10% Italy 41 Germany 36.1 Britain 35.9 Spain 35.5 Canada 34.1 U.S. 28.6 Japan 27.1 Mexico 17.8 China 16.8

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Source: IMD World Competitiveness Yearbook 2004

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Researcher Froylan Enciso in The Times’ Mexico City Bureau contributed to this report.