Publish in Perspectives - Wednesday, March 5, 2014
President Enrique Peña Nieto when he presented the fiscal reform to Mexico's Congress in September 2013. (Photo: Mexican President's Office)
initial results prove disappointing, adjustments in Mexico’s fiscal reform will
BY SUSAN KAUFMAN PURCELL
Over the past several months, President Enrique Peña Nieto of Mexico has been actively engaged in implementing his ambitious reform agenda. The energy reform has generated the most excitement, both within and outside of Mexico, but the fiscal reform is particularly interesting because of what it reveals about the president’s ideas regarding the drivers of economic growth and development.
Peña Nieto wants to increase the rate and pace of Mexico’s economic growth, while reducing inequality. These priorities are understandable, given the fact that Mexico’s GDP increased an average of only 2 percent over the past decade. Moreover, while Mexico’s South American neighbors profited from the commodities boom of 2005-2010, Mexico’s dysfunctional energy policy produced declining oil exports. The commodities boom has ended due to China’s slowing economy, with a narrowing of the gap between wages in Mexico and China. Mexico now believes that it can achieve higher rates of growth and development if it adopts the right kinds of policies.
The recent fiscal reform is one of the president’s high-priority reforms. Its main provisions increase the tax rate on the wealthy and on the private sector and add a number of additional taxes that will negatively affect Mexico’s emerging middle class. The additional revenue that will flow to the government will provide it with more money to spend on social policies, such as pensions, to benefit the lower class. It will also help wean the government from its dependence on taxes it has been receiving from PEMEX which represent approximately one third of the government’s budget. The reform also simplifies the tax code, reducing significantly the number of days it will take businesses to file their tax returns.
It is interesting to note what the fiscal reform did not do. For example, it did not broaden the tax base by taxing the informal sector of the economy, which constitutes approximately 65 percent of the Mexican economy. In fact, it provides a perverse incentive by limiting coverage under the new “universal pension” only to workers in the informal sector. The reform also contains no provisions to encourage greater productivity, efficiency or accountability of big state enterprises such as PEMEX and CFE, the government electric company. Furthermore, the fiscal reform does not include any initiatives to reduce government spending. In fact, it goes in the opposite direction by increasing the budget deficit for 2013 and 2014, which the government plans to offset by increasing its debt. Nor did the reform make clear how the new revenue flowing to the state will be used, particularly since only about 5 percent of these revenues has been designated for social spending.
Perhaps most important, the government did not explain how or why the fiscal reform would produce higher rates of growth and productivity. Apparently, the Peña Nieto administration believes that the public sector is better able to produce economic growth and attract domestic and foreign investment than the private sector, and that higher taxes will not discourage economic growth if some of the tax money is used to alleviate poverty. Mexico’s income and value-added taxes, however, were already relatively high before the recent fiscal reform. Despite this fact, economic growth has been weak. Without broadening its tax base to include members of the informal sector, and without reducing tax evasion, it is difficult to see where economic growth will come from.
Apparently, the government is counting on the energy reform to resolve this problem by attracting private investment and technology that will make the energy sector more efficient, productive and competitive. It is betting that oil prices will remain relatively high.
Nevertheless, a fiscal reform is not only about economics and finance; it also involves politics. Mexico is now a multiparty democracy whose leaders must work constructively. The passage of the fiscal reform should be viewed as a first step - important but not definitive - in achieving the objectives of the Peña Nieto administration. If the initial results prove disappointing, adjustments in the reform will be needed, as well as a willingness on the part of the government to build the political support to implement them.
Susan Purcell is Director, Center for Hemispheric Policy, University of Miami. This article was published in Spanish in the February 2014 issue of AmericaEconomia. Republished with permission.