Monday, July 16, 2007

Mexico Needs Calderón’s Proposed Fiscal Reforms

By Patrick Corcoran

The likely passage of President Felipe Calderon’s recent fiscal reform proposal would provide the young leader with more legislative victories in the first year of administration — two — than his predecessor had in his entire six-year term. Congressional approval of the plan would, more importantly, also be an important step in modernizing Mexico’s economy.

Mexico suffers from an appallingly high tax evasion rate: roughly 40 percent of businesses are estimated to skim off the government’s take. Governments, as you no doubt have heard, typically rely on taxes to operate, so rampant evasion should be a most pressing concern. But Mexico’s government depends less on taxes than most, instead leaning heavily on the national oil company, Pemex, for its financing. (Mexico’s oil fields, particularly the once gargantuan but rapidly dwindling Cantarell Field, supply the federal government with about 40 percent of its operating income.) Consequently, the government has long ignored the abysmal tax situation while pilfering Pemex. 

But this state of affairs is no longer tenable. Pemex, thanks to the government leeching off of it, is woeful, saddled with debt and in desperate need of outside technology as it searches for more oil in the deep waters of the Gulf of Mexico. Mexico’s government, addicted to crude, stares into an abyss of insolvency as Pemex faces a sharp drop-off in production.

Calderon’s fiscal reform aims to correct all of that (well, at least some it): it will increase corporate tax collection, lower tax evasion, and reduce the government’s reliance on oil revenues, all in one fell swoop.

The main mechanism for this fiscal abracadabra will be the Flat Rate Business Contribution (known as the CETU, for its initials in Spanish). The CETU targets businesses that presently pay the Tax on Profit (ISR), whose loopholes have long allowed businesses to avoid paying their fair share. The CETU will not, however, replace the ISR; the two taxes will work in tandem. Agustín Carstens, who heads up Mexico’s version of the Treasury Department, said the two-tax tag-team will seal loopholes and allow the government to collect about 25 percent more in tax revenues.

The plan has sparked opposition among businesses, which claim that the combination tax application is unduly complicated and will impose an unfair burden on businesses. This is a disingenuous critique. Corporate taxes are rarely simple, but at least conceptually the CETU application is not rocket science. As individuals do with the alternative minimum tax in the United States, corporations will simply calculate two tax obligations, and pay the higher of the two.

Any business balking at the imposition of a new tax is hard to accept as a serious critique of the proposal’s viability. Opposition from businessmen stems from the realization that the sun is about to set on the sweetheart deal they have enjoyed in Mexico for generations. Their apprehension can be taken as a sign that the reform plan will correct some of the fiscal madness that prevails today.

The political left stands on firmer ground when it criticizes the reform, as there are legitimate concerns that already struggling small and medium businesses are going to take a big hit. However, the fact is that while this isn’t the mass wealth redistribution that many on the left would want, it is more favorable to the poor than it is to the wealthy patrons of Calderon’s own National Action Party.

Calderon’s team chose not to include a value-added tax on medicine and food staples, as it would have placed the burden of fiscal correction on the backs of the poor. Instead, the reformed tax code will be both more modern and more progressive. It will force some smaller businesses to pay taxes that they weren’t previously paying, but in the process it will bring thousands of informal businesses into the legitimate economy, a perennial goal for Latin American economic policy managers. The plan cannot honestly be painted as a sop to the rich at the expense of the poor.

The plan may not go far enough, but one can forgive Calderon for taking baby steps. He needs to walk a very fine line, tossing out just enough goodies to draw each one of the major groups into his tent without scaring the rest in the process. Calderon is vulnerable to attacks from both his own party (which has been less than loyal to the president) and from the leftist Party of the Democratic Revolution, which remains intensely bitter about Calderon’s victory one year ago and skeptical about his motives. 

Calderon’s support, while high among the general population, is tenuous. Any reform too radical to hold together a coalition to pass it could frustrate his legislative prospects in the future. A failed fiscal reform would embolden his adversaries, and could lead to several more years of legislative gridlock.

If the proposal falls short, it isn’t just Calderon’s loss — but Mexico’s.

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Patrick Corcoran, a MexiData.info columnist, is a writer who resides in Torreón, Coahuila.  He can be reached at corcoran25@hotmail.com.