LEADING MEXICAN ECONOMIST ON TAX AND FISCAL REFORM

C O N F I D E N T I A L SECTION 01 OF 02 MEXICO 004189

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FOR WHA/MEX, WHA/EPC, EB/IED
TREASURY FOR IA MEXICO DESK: JASPER HOEK
COMMERCE FOR ITA/MAC/NAFTA: ANDREW RUDMAN
ENERGY FOR KDEUTSCH AND SLADISWAN

E.O. 12958: DECL: 07/27/2016
TAGS: ECON EFIN ENRG MX PGOV PINR PREL
SUBJECT: LEADING MEXICAN ECONOMIST ON TAX AND FISCAL REFORM
ISSUES


Classified By: Economic Minister Counselor Vlad Sambaiew
for reasons 1.4 (b) and (d)


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Introduction and Summary
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1. (C) Econoff met with Dr. Fausto Hernandez, Economics
Professor at Mexico,s Center for Economic Research and
Teaching (CIDE),to discuss Mexico,s fiscal policy. Dr.
Hernandez has done extensive research and published numerous
studies on the subject. He discussed the origins of low tax
collection rates in Mexico, reasons for high tax evasion, and
the viability of passing fiscal reform during the next
administration. Dr. Hernandez highlighted the consistently
increasing informal economy in Mexico, and the fact that the
incentives to evade taxes are greater than the costs of
compliance. Despite the fact that fiscal reform seems to
other economists as the most doable of needed Mexican
structural reforms, Hernandez concluded that an overall
fiscal reform would be unattainable and the feasibility of
passing portions of a fiscal reform seem minimal. End
Summary.

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Mexico,s Tax Collection and Tax Evasion
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2. (C) Dr. Hernandez explained that total tax collection in
Mexico is only 9.8 percent of GDP. Mexico is the third
lowest collector of taxes in Latin America, after Haiti and
Guatemala. Under Mexico,s fiscal system, people are
classified as &Moral People8 (those that own a business or
corporation) and &Physical People8. Thirty-nine percent of
moral people do not pay taxes, and 77 percent of physical
people evade tax payment. Most of the proposals for a fiscal
reform have recommended an increase in tax collection to only
12 percent of GDP, including Impuesto sobre el Valor Agregado
(IVA),the equivalent to VAT.


3. (C) Despite the low tax collection rates, Hernandez said
that, Mexico has very competitive tax rates of 20 to 22
percent of GDP, including IVA, which are similar to those of
the U.S. The reason for Mexico,s competitive tax rates is
that a provision under NAFTA stated that the tax rates of the
countries participating in this agreement need to be similar
to each other. At the same time, Hernandez explained that
the two factors that contribute to Mexico,s meager personal
and corporate tax collection are evasion and avoidance.


4. (C) He noted that impunity in Mexico contributes to the
country,s high tax evasion. In Mexico, the probability of
evasion detection is very low, and the likelihood of being
penalized is even lower as the capacity to negotiate is
always an alternative. In short, there is little incentive
to pay taxes.


5. (C) Moreover, Hernandez said that the complexity of the
fiscal law creates loopholes that facilitate tax avoidance
while complicating the work of the Servicio de Administracion
Tributaria (SAT),the equivalent to IRS. These loopholes are
primarily created by many &Legal Privileges8 or more
commonly known as exceptions. According to Hernandez, the
GOM created theses exceptions to meet the interests of
certain sectors, such as agriculture or transportation. If
these exceptions were reduced then tax collection would
increase by 3 to 4 percent of GDP.


6. (C) Mexico,s confidentiality laws, Hernandez explained,
should cease to exist, as they impede tax collection and
prevent the SAT, from performing uniform comparisons while
hampering the transparency of the process. Furthermore, the
SAT does not have the needed tools or ability to organize
information collectively, only individually, hence precluding
comparisons amongst sectors or groups, which could facilitate
detection of disparities and outliers.

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IVA Rates
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7 (C) Hernandez stressed that, in order to reduce evasion; an
integral reform with a flat IVA rate is needed. Currently

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there are four different IVA rates: zero rate, exempt, border
rate, and general rate. Food and medicines fall under the
zero rate category, which means that zero taxes are paid for
the entire process, which is composed of five stages, of
creating a specific food. This mainly benefits all the big
and wealthy corporations that produce food or beverages such
as Jumex. Books fall under the exempt category, because they
are exempt to pay taxes for the fifth stage, and only pay
taxes in the first four stages. The border rate was created
to charge businesses along the border tax rates competitive
to those charged on the other side of the border. However,
according to Hernandez many businesses claim that their
products are sold along the border, and thus avoid paying the
higher general tax rate.

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Feasibility of Passing a Flat Income Tax Rate Reform
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8. (C) Hernandez explained that Calderon,s proposal for
simple flat income tax rate is good, yet it will be extremely
difficult to obtain its approval as an amendment to the
Mexican Constitution is allegedly needed to pass a flat
income tax rate, he said. Article 31, fraction IV, of the
Mexican Constitution stipulates that the Mexican tax system
must be based on proportionality. Congruence should exist
between the tax contribution or payment and the capacity of
the taxpayer to make such a contribution, which is understood
as the real potential to contribute to public expense. In
other words, tax contribution is proportional. Those who
earn more have a greater capacity to contribute more than
those that earn less. Hernandez explained, a way to approve
this reform without changing the constitution would be to
exempt not only those who earn the equivalent to five minimum
salaries, like Calderon proposes, but to establish a
reduction base for everyone equivalent to five minimum
salaries. This, analysts agree, would generate a sense of
proportionality, as required in the Mexican constitution,
benefiting primarily those that earn less.


9. (C) On the other hand, Hernandez explained that changing
the IVA rate to a single rate, instead of four, does not
require an amendment to the constitution. This would
simplify matters, Hernandez added, as the IVA rate is highly
politicized and there are many interest groups that oppose to
any changes. Among the interest groups that oppose changes
to the IVA rate are the business-owners, who according to
Hernandez, are highly respected by many government officials,
including Secretary of Hacienda (Treasury) Francisco Gil
Diaz. Furthermore, Agustin Carstens, Deputy Managing
Director of the IMF and possible candidate to become the next
Secretary of Hacienda, also belongs to this interest group,

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Hernandez said. Therefore, according to Hernandez, any
proposed changes to the IVA rate are unlikely to be approved.



10. (C) Mexico,s fiscal problem, Hernandez noted, is the
result of the lack of leadership and political willingness to
make needed changes to increase tax collection and reduce
evasion in Mexico. In addition, Hernandez concluded the long
history of corruption has become a major factor that needs to
be eradicated at all levels in order to make positive real
change in the country.

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Comment
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11. (C) Dr. Hernandez, expertise and keenness on the
subjects above provide useful perspectives on the feasibility
of passing needed fiscal and tax reform in the near term,
particularly given the fact that a constitutional amendment
might be needed. It is, of course, too early to predict how
a new GOM will proceed with structural and fiscal reforms.
To give Washington agencies a better sense of the economic
debates here, we will continue to provide views of leading
Mexican economists on the challenges the new GOM will face.
End Comment.


Visit Mexico City's Classified Web Site at
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