FISCAL REFORM: CURRENT STATUS

UNCLAS SECTION 01 OF 03 MEXICO 004280 SIPDIS SENSITIVE SIPDIS SECSTATE FOR A/S SHANNON SECSTATE FOR WHA/MEX, WHA/ESP, EB/IBF/OMA SECSTATE FOR EB/ESC MCMANUS AND IZZO USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD USDOC FOR ITS/TD/ENERGY DIVISION TREASURY FOR IA (ALICE FAIBISHENKO) DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOD SECSTATE PASS TO USTR (EISSENSTAT/MELLE) SECSTATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) NSC FOR DAN FISK E.O. 12958: N/A TAGS: ECON BEXP SENV EAID PGOV EFIN EINV MX SUBJECT: FISCAL REFORM: CURRENT STATUS REF: A. MEXICO 3246 ¶1. (U) Summary: Mexico's opposition parties continue to deliberate on whether to allow a Special Session so that Congress could rule on Calderon's fiscal reform proposal before the FY 2008 budget must be submitted on September 8. Despite criticism of the CETU minimum alternative tax by business, a leading Mexico NGO, the Mexican Competitiveness Institute (IMCO),sees the CETU as a needed modernization of Mexico's current fiscal regime that would increase investment and job creation. Because expanding Mexico's tax base is not currently politically possible, the Calderon Administration has little leeway to meet industry demands to lower the CETU rate or increase deductions. Even critics of the CETU acknowledge that the worst outcome would be for the Congress to block Calderon's attempt at fiscal reform. End Summary. PRI and PRD Views -------------- ¶2. (U) While Finance Secretary Augustin Carstens and President Calderon continue to lobby for their tax reform proposal, the PRI and PRD opposition parties are debating whether to call a special Congressional session in August to approve the reform before the FY 2008 budget package is due to be sent to Congress on September 8. The PRI will discuss its proposed changes to the fiscal reform during its party plenary on August 19-21 in Veracruz. Proposed changes being considered by the PRI include reducing the Single Rate Business Tax (CETU) by 3%, eliminating the tax on spray paint, earmarking resources from the "informality tax" on cash deposits over 20,000 Mexican pesos a month, and preventing taxes being collected on remittances. Some PAN legislators have proposed reducing the CETU by 2%. The Finance Ministry warned that each percentage point drop in the CETU would reduce government revenue by USD 1 billion. Praise for the Fiscal Reform -------------- ¶3. (U) Whether the fiscal reform will generate enough revenue, and how that revenue will be used is a key part of the ongoing debate. Those analysts publicly supporting fiscal reform note the importance of increasing government revenue. Moody's senior economist for Latin America, Alfredo Coutino predicted that financial markets would rally with the approval of the tax reform due to the importance of generating the additional revenue equivalent to 2% of GDP. ¶4. (U) Roberto Newell, Director General of the Mexican Competitiveness Institute (IMCO, a leading non-governmental organization) used an Op-Ed piece in a leading newspaper to defend Calderon's proposal. Newell noted that given PRI and PRD opposition to expanding the Value-Added tax (VAT),the CETU was the best available option. While Newell admitted the CETU tax was not perfect, he said it was a necessary means to get around the many exemptions that keep collections of the current income tax (ISR) well below what is needed for a healthy economy. He explained that the CETU puts a much-needed floor on collections, ensuring that businesses pay a minimum level of tax. He claimed that the CETU will actually increase incentives for investment and job creation in the formal economy. Because the CETU is a much simplified tax, and the CETU's rate is well below the marginal rate for the current "ISR" income tax, it would be a step toward a more modern, effective tax regime that would promote investment and growth. Newell expressed the hope that that over time, the old fiscal regime would be replaced by the simpler, more modern system started with the CETU. Maquiladoras Criticize the Reform Proposal MEXICO 00004280 002 OF 003 -------------- ¶5. (U) The National Council for the Maquiladora Export Industry (CNIME),took the opposite view in their August 7 discussion with Econoff. The CNMIE said the CETU would stifle investment and job creation, particularly in labor intensive sectors such as their own. CNIME President Jose de Jesus Calleros said that the maquila industry is particularly affected by the CETU because of the inability to claim deductions for labor costs which constitute 70 percent of the industry's expenditures. He said that if the CETU is passed as currently presented, Mexico would become less competitive as investors and businesses move to countries with a more favorable tax structure. Mexico Needs Help to Expand its Tax Base -------------- ¶6. (U) Citibank, Proctor and Gamble, Daimler Chrysler and 33 other corporations under the Executive Council on Global Corporations (CEEG) have written to authorities requesting changes in the tax reform to expand the base of taxpayers, and improve control and transparency of government spending. The CEEG said investors needed certainty that government resources will be spent on social programs such as health, education, housing and infrastructure. ¶7. (U) The CEEG gets at the heart of Mexico's fiscal reform debate. The PRI and PRD will not accept expansion of the VAT, and the government is finding it extremely difficult to expand the tax base beyond those firms and people currently paying taxes. Recent visitors from U.S. Treasury's Office of Technical Assistance told Emboffs of the very great need of Mexico's tax authorities (SAT) for technical assistance to learn how to go after businesses and people who do not pay taxes. OTA also noted the strong commitment and desire of the SAT managers who want to improve tax collection processes. OTA said that SAT clearly recognizes that they need to go after tax evaders. More Tax Revenue is Needed -------------- ¶8. (U) The CEEG has joined many politicians and other observers in making demands that the increased government revenue from the fiscal reform fund badly needed infrastructure, education, health and housing. It is unclear whether that will happen, however. Francisco Suarez Davila, PRI former Undersecretary of Finances and former chairman of Congress' Committee publicly warned that most of the expected resources from the tax reform will be channeled to the teachers union SNTE due to an agreement made by then-President Fox and the SNTE in October 2006 (Ref A). Suarez claimed little will remain to address social needs, explaining that the Finance Ministry expects to collect 130 billion Mexican pesos form the CETU, but 50 billion will go to pay teachers salaries, and 3 percent net of GDP will go to pay pensions and Pidieragas (off-the books government debt) maturities. Comment -------------- ¶9. (U) Although Calderon's fiscal reform proposal is not the broad reform most had expected, and does not significantly expand Mexico's narrow tax base, it is a step forward; and many observers expect Calderon to propose a broader fiscal reform later during his term if the current reform passes the Congress. The government is in a difficult position. Investors are claiming that the CETU rate must be reduced, and increased deductions allowed from the CETU or employment will suffer. The government desperately needs to increase tax revenue, however. The maquiladora industry, which is de-crying increased taxes of upwards of 600%, currently pays a tax MEXICO 00004280 003 OF 003 rate of 1% on total income (see septel). The current tax regime keeps taxes extremely low through a complicated system of deductions and exemptions. There is currently no political will in the Mexican Congress, and perhaps within the Calderon Administration, to take on the special interests to dismantle these special privileges. Finance Secretary Carstens said both publicly and privately that success in achieving economic reform depends on the Administration knowing when to pick its battles. As long as oil production continues to decline, Mexico must increase the taxes that its firms and individuals pay. Since PRI and PRD opposition prevents expanding the VAT, the government will have limited options for finding other revenue sources if it agrees to reduce the amount to be collected through the CETU. ¶10. (SBU) Comment: Even those who complain about the tax reform, such as the American Chamber of Commerce, note that the worst case would be for the reform to fail. Not only would financial markets be disappointed at Mexico's failure to make even a moderate fix to its broken fiscal regime, but it would weaken President Calderon's credibility to achieve consensus to advance his reform agenda. End Comment GARZA