Government claims tax reform is unnecessary
In a 2 July interview with Spanish daily, El País, Mexico’s former finance minister Carlos Manuel Urzúa (2018-2019) highlighted that one of the most significant problems that governments in Mexico face at present –both at the federal and state level- is a lack of funds because tax revenue is only around 14.5% of GDP.
Down from 16.5% in 2019, the tax revenue figure is one of the lowest in Latin America – 6.5 percentage points below the regional average- and among the Organisation for Economic Cooperation and Development (OECD) – 17.3 percentage points below the average of the bloc of mainly rich counties. Compared to the rest of Latin America, the most significant differences are related to low revenue from value-added tax (VAT), while relative to the OECD Mexico fares particularly badly in terms of social security tax revenue.
Given that Mexico’s economic growth has been falling –even before the coronavirus (Covid-19) pandemic started in 2020—this low tax revenue is only likely to worsen. Crucially, Urzúa pointed out that while existing fiscal stabilisation funds can make up for the shortfall in earnings of federal and state governments in the short term, this situation can only be sustained for only a few months before the stabilisation funds will run out. Urzúa’s comments paint a worrying picture of Mexico’s public finances that seem to highlight the urgent need for fiscal reform in the country. Other finance experts and academics have similarly called on the government led by President Andrés Manuel López Obrador to amend the country’s tax framework to increase state revenue.
According to Daniela Salgado of Integralia, a local economic consultancy, Mexico’s low tax revenue levels is due to several causes: a tradition of reliance on oil proceeds; poor tax collection from states and municipalities; low structural economic growth levels; high labour informality; extensive tax exemptions and deductions; and high levels of tax evasion. Figures from the federal finance ministry (SHCP), Mexico’s tax income and government spending gaps are largely produced by the extent of zero-rated VAT goods and exemptions in personal income tax. Meanwhile local think-tank, México ¿Cómo Vamos?, notes that due to the López Obrador government’s refusal to increase national debt levels, it is essential to raise additional public funds through a fiscal reform, not only to cover urgent government expenditure but also to able to cope with unforeseen crises.
Indeed, some argue that the extremely limited measures adopted by the López Obrador government in response to the Covid-19 public health emergency and associated economic crisis were largely due to its narrow fiscal space. México ¿Cómo Vamos? says that a considerable and sustainable increase in tax revenue is essential and suggests that to achieve this not only is expanding the the tax base necessary but also to make the tax system more progressive and simpler so as to help reduce labour informality. It is also argued that shore up public finances will also require modifying public expenditure and reduce the level spending, particularly in some of the large but loss-making state-owned firms such as oil firm Pemex and the electricity utility firm, CFE. These reforms, it is noted, would allow for the continued support of vulnerable populations and sustaining major infrastructure projects, both of which are declared priorities of the López Obrador administration.
With its majority in the federal congress the ruling Movimiento Regeneración Nacional (Morena) party could easily introduce changes to the tax framework. However, while some party representatives and members of the government have at different times said that there are plans to carry out a tax reform, on 8 July President López Obrador stated that there will be no such initiative presented in the new legislative period that starts on 1 September. López Obrador says that his government’s austerity drive and determination to fight against corruption, which includes a crackdown on tax evasion, makes a tax reform unnecessary. A major factor behind López Obrador’s refusal to acknowledge the urgency of a reform may be his campaign promise not to raise taxes. Doing a U-turn on this would undoubtedly have a political cost that could undermine support for his government.
However, López Obrador’s reticence may also be explained by the fact that tax revenue was actually better than expected in 2020 –despite the effects of the pandemic- thanks to a more effective tax collection. Having said that, government expenditure projections for this year– due to the expansion of some social programmes, such as the old age pension for the poor, and spending in major infrastructure such as the ‘Tren Maya’ railway and the Dos Bocas new oil refinery- have substantially increased. Carrying out a tax reform could also further deteriorate relations with Mexico’s business sector and the middle class, two sectors with which the López Obrador administration has already clashed at different times, and which could also have a significant political cost.