EEB A/S SULLIVAN DISCUSSES FISCAL AND PEMEX REFORM

C O N F I D E N T I A L SECTION 01 OF 03 MEXICO 004815

SIPDIS

SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD
NSC FOR RICHARD MILES, DAN FISK
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)

E.O. 12958: DECL: 04/05/2011
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: EEB A/S SULLIVAN DISCUSSES FISCAL AND PEMEX REFORM
WITH MEXICAN FINANCE U/S WERNER AND AMCHAM

REF: A. MEXICO 4552


B. MEXICO 4282

C. MEXICO 4280

D. MEXICO 4236

E. MEXICO 4191

F. MEXICO 4151

G. MEXICO 4015

H. MEXICO 3246

I. MONTERREY 725

Classified By: Economic Officer Laura M. Lausier, REASONS 1.4(b) and 1.
4(d)

Summary
--------------


1. (C) In an August 29 meeting with Assistant Secretary for
Economic, Energy and Business Affairs Daniel Sullivan, Under
Secretary of Finance Alejandro Werner expressed confidence

SIPDIS
that changes to the proposed Mexican Single Rate Income Tax
for businesses (CETU) would allow the tax to be creditable
against U.S. income taxes. He then described other proposed
congressional changes that would make the new regime more
palatable to business. Werner noted that progress on
intra-party negotiations has slowed as a result of PRI
questions over gasoline taxes, as well as PRI insistence on
changes to Pemex's tax regime. Despite these delays, Werner
expected the overall reform to be completed within 3 weeks,
adding that it would increase tax revenue by 2.4-2.5 percent
of GDP versus the 3 percent originally proposed. A/S
Sullivan also discussed the upcoming Major Economies Meeting
on Climate Change, reported Septel. End Summary.


2. (C) In an August 29 meeting with visiting A/S of State Dan
Sullivan, Under Secretary of Finance Alejandro Werner
(strictly protect) discussed negotiations and prospects for
the tax reform proposal the Calderon administration floated
in June (see refs A-I). Werner said that negotiations have
centered on a few key issues. The most significant changes
to the government's proposal entail resolving issues
regarding the CETU, the Single Rate Income Tax for
businesses. The government proposal did not allow for the
deductibility of wages, and there were issues regarding the
CETU's creditability against U.S. income tax under the
U.S.-Mexico tax treaty. Werner sounded confident that the
creditability issue would be resolved. (Note: During a
separate discussion with visiting U.S. Congressman Roy Blunt
on August 21, Werner said negotiations with Treasury had led
to Treasury's "understanding" the Mexican tax proposal, and
that changes proposed during informal discussions with the
Mexican Congress were making the CETU look more like U.S.
corporate income tax, which would make it creditable against
U.S. taxes. Werner said the tax, which is currently labeled
a contribution -- thus CETU -- might end up being called a
tax, or ITU (the Spanish word impuesto means tax) to
emphasize its link to corporate income. End Note.)


3. (C) According to Werner, an additional significant change
to the government's proposal is the introduction of a
transition period from the old tax regime to the new system.
Under the CETU, businesses cannot deduct interest on debt,
which presents a problem for companies that invested a few
years ago because they cannot deduct benefits accumulated
under the old tax regime. To accommodate businesses who made
investment decisions under the old regime, Werner said the
GOM will calculate an "average tax credit" that can be
credited to the new system.


4. (C) Werner said that the state tax on gasoline and diesel
also has proved to be a stumbling block in negotiations. The
PRI, which initially supported this tax, wavered because it
came under fire in the run up to local elections in Veracruz.
Werner said that the government was trying to negotiate this

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issue.


5. (C) The PRI's introduction of changes to Pemex' tax regime
also has complicated negotiations. Since this tax regime was
changed just a few years ago, Werner believes that the GOM
should wait and see if more changes are needed. Werner added
that if Mexico were to allow private sector participation in
the energy sector, Pemex would require an entirely new tax
system. First, he argued, Mexico should focus on making
Pemex more efficient. Nonetheless, Werner said that since
the PRI put this proposal on the table, the government would
have to negotiate a feasible alternative.


6. (C) In response to a query from A/S Sullivan as to why the
PRI introduced the Pemex proposal now, Werner responded that
the party wanted to showcase a forward-leaning posture on
economic reform. The new tax reform will increase government
revenue, and the PRI wants to make sure that Pemex receives a
part of this boon. According to Werner, since the PRI is
supporting fiscal reform -- something that is clearly on the
government's agenda -- it wanted to push some things on its
own agenda (i.e., Pemex and electoral reform) for political
cover.


7. (C) Werner believes that tax reform will be approved. He
said that technical issues are not an obstacle at this point,
and that the remaining steps are political in nature. If
parties can find common ground, the reform could be approved
as early the week of September 3. The issues discussed above
have slowed the passage of fiscal reform, but Werner said the
initiative could be approved within 3 weeks. He estimated
that the reform would increase tax collection by 2.4-2.5
percent of GDP, versus the 3 percent envisioned in the
government's initial proposal.


8. (C) Werner noted that the government's non-oil tax intake
is only 10 percent of GDP, so Mexico will need to do more
work down the road to reduce government dependence on oil
revenues, such as by fixing the value-added tax (VAT). He
made reference to three prior unsuccessful attempts by former
President Fox to address the VAT, and added that Calderon
himself said that the VAT would not be addressed in the
current reform proposal. Werner also mentioned the need to
build a framework to make public spending more accountable.


9. (C) Werner said that the passage of tax reform would open
the door for Calderon to pursue other economic objectives,
including energy reform. He noted that telecommunications
and energy reform were key components of increasing
employment and competitiveness. Separately, Werner said he
had heard that A/S Sullivan's meeting with Under Secretary
for Communications Rafael del Villar went well (see septel).

American Chamber of Commerce
--------------


10. (SBU) At an August 30 AmCham breakfast with A/S Sullivan,
a representative of a U.S. energy company emphasized the
importance of opening up the energy sector to some form of
private participation. He argued that while improving Pemex'
efficiency was a laudable goal, it is impossible for one
company to efficiently exploit all of Mexico's oil in the
Gulf of Mexico.


11. (SBU) Chamber President Larry Rubin said Finance
Minister Carstens had asked the Chamber to approach the IRS
about creditability of the proposed corporate tax. Rubin
reported Carstens had said that while Treasury now agreed the
proposed new tax would be creditable, IRS lawyers were
"holding out." A/S Sullivan promised to inquire in
Washington.


12. (SBU) This telegram has been cleared with A/S Dan

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Sullivan.


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