MEXICO'S TAX REFORM BILL NEARING ADOPTION

UNCLAS SECTION 01 OF 03 MEXICO 004970

SIPDIS

SENSITIVE
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: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: MEXICO'S TAX REFORM BILL NEARING ADOPTION

REF: A. MEXICO 4815

B. MEXICO 4552

C. MEXICO 4282

D. MEXICO 4280

E. MEXICO 4236

F. MEXICO 4191

G. MEXICO 4151

H. MEXICO 4015

I. MEXICO 3246

J. MONTERREY 725

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Summary and Introduction
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1. (SBU) President Calderon's economic team and political
parties, mainly the National Action Party (PAN) and the
Institutional Revolutionary Party (PRI),have reached a
consensus on almost all issues included in the tax reform
bill. Legislators in the finance committee of the Chamber of
Deputies discussed and approved on September 12 the seven
bills included in the fiscal reform. With some changes, the
tax reform aims to increase federal tax collection by 2.5
percent of GDP by 2012 and at least USD 9 billion in 2008.
The tax reform bill could be adopted as early as September 13
in the Chamber of Deputies. The bill had been put off until
political parties had reached agreement on an electoral
reform bill being discussed at the same time in the Senate.
The electoral reform bill was approved on September 12 in the
Senate (it now faces a vote in the Chamber of Deputies),
opening the way for approval of tax reform. Although it is a
step in the right direction, the tax proposal is not the bold
reform needed to fully address Mexico's low level of tax
collection and declining oil production. End Summary.

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Congress' Proposal and Changes
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2. (U) The Calderon government's fiscal reform proposal
remains centered on a new alternative minimum tax designed to
prevent companies from using deductions and loopholes to
significantly reduce their tax payments. The original
alternative minimum tax, (CETU, Single Rate Business
Contribution) has been modified, and is now called the Single
Rate Business Tax (IETU) because legislators believe it is
more appropriate to call it a tax, rather than a
contribution. Ministry of Finance Under Secretary Alejandro
Werner has told Econoffs that he believes the modified IETU
tax would be creditable against U.S. taxes. Mexico's
legislators have said the Calderon Administration would be
responsible for getting other countries to accept the
creditability of the IETU under tax treaties.


3. (U) As originally proposed, the CETU rate would have been
16 percent in 2008 and 19 percent starting in 2009. However,
to sooth private sector concerns, legislators agreed to
reduce the IETU to 16.5 percent in 2008, and gradually
increase it to 17 percent in 2009, and 17.5 percent in 2010.
The private sector is still calling for the tax to be reduced
to 16 percent.


4. (U) Addressing industry and maquila concerns about hurting
job creation, Congress also proposed allowing deductions for
salaries and other labor costs, such as fees for social
security. Investments made during the last quarter of 2007
will also be deductible for the next three years. A
transition period for fixed assets' amortization was also
approved.


5. (U) Calderon's original proposal included a 2-percent levy
on monthly cash bank deposits of more than 20,000 pesos (USD
1,835) -- a tax that can be credited against income taxes --

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and measures to fight tax evasion. Legislators raised the
monthly threshold on cash deposits to 25,000 pesos (USD
2,230). To allow banks to prepare their systems to be able
to collect the tax, the measure will not be effective until
July 1, 2008. Legislators agreed to keep the government's
proposal to introduce a 20-percent tax on lotteries and
gambling-related income, but discarded the 50-percent tax on
aerosol paints. The Congress also met public concerns by
allowing tax deductions for charitable donations -- with some
restrictions to prevent companies from using this as a
mechanism for tax evasion -- and deductions for small
agricultural producers.

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Complying With Political Commitments
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6. (U) The legislature has dropped Calderon's proposal to
grant states the authority to collect local taxes on tobacco,
gasoline, and beer, because governors did not want to assume
the political cost of directly collecting those taxes. The
Institutional Revolutionary Party (PRI) and the National
Action Party (PAN) agreed on a 5.5-percent increase in
gasoline prices, which would be collected by the federal
government. Additional resources obtained from the gas tax
hike would be completely transferred to the states and
municipalities provided they sign an agreement with the
federal government, in which they commit to use the resources
for infrastructure projects. Legislators agreed to increase
gasoline prices gradually and include a subsidy for the ten
poorest states. The proposal approved on September 12
provides for an increase in the price of gasoline by 2 cents
each month over an 18-month period making for a 36 cent
increase at the end of this period in order to reduce the
expected 0.3-percent inflationary impact. Some PRI and PAN
lawmakers were reluctant to approve the gas tax increase, but
providing the additional revenue to local governments was a
commitment made to get governors to support tax reform. The
Democratic Revolution Party (PRD) legislators have already
announced that they will vote against a gas price increase
out of stated concern over the impact on the lower class.


7. (U) Concurrent with giving the states more revenue was the
desire of the Calderon Administration to make the states more
accountable for how they spend government funds. Under the
new proposal, Congress' Fiscal Auditor is given more power to
audit transfers of federal resources to the states. To make
overall government spending more efficient, opposition
legislators introduced a proposal to lower the government's
current expenditures by 20 percent during Calderon's term, 5
percent every year, in addition to the USD 933 million
proposed by the government in its 2008 budget package.


8. (U) The PAN and PRI included a proposal previously made by
the PRD to levy company acquisitions through the Mexican
Stock Market, which are currently tax exempt.


9. (U) The Congress is agreeing with Calderon's effort to
give more teeth to the Tax Administration System (rough
equivalent of the IRS) to fight tax evasion. The current
legislation raises sanctions on accountants who promote tax
evasion.


10. (U) Congressional approval of Calderon's tax reform
proposal, was made subject to the passage of a PRI proposal
to reform Pemex's "tax system," i.e. the amount of Pemex
revenue going directly to the government. On September 11,
legislators approved a new tax regime for the state-run
company, which would provide allow it to keep an additional
USD 2.7 billion in 2008 and up to USD 5 billion by 2012.
Legislators will earmark these additional resources so that
Pemex invests them in increasing its production and research,
rather than for current expenditures. The reform is expected

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to help Pemex increase its production to 200,000 of barrels a
day by 2010 or 2011. The tax paid by Pemex to the government
will decrease from 78 percent to 71.5 percent over a five
year period.

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Proposal Nearing Adoption
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11. (SBU) Fiscal reform could be approved by the Chamber of
Deputies as early as this week and passed to the Senate for a
vote next week. Although Calderon's 2008 budget proposal did
not include additional revenue from tax reform, the Chamber
could still approve tax reform before the October 20 deadline
for passing the revenue component of the budget (the "Revenue
Law"). The Finance Secretariat is working with Congress to
amend the proposed 2008 budget to reflect changes in
government revenue made by legislators.

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Comment
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12. (SBU) The process of building consensus with different
political forces, governors, and the private sector proved
difficult, especially when opposition legislators linked tax
and electoral reform. Given Congress' composition, Calderon
needed PRI support to pass the tax reform bill which has long
been his priority. The PRI finally supported the tax reform,
although with changes to the initial proposal.
Interestingly, many of the PRI's changes resolved concerns
registered by the Mexican and international business
community. On a broader level, the PRI seems to understand
that if it wants to contend for the 2012 presidential
elections, it needs to project an image of itself as party
working for constructive reform as opposed to a party
blocking such efforts. The PRI also seems to appreciate the
wisdom of addressing existing pressures on public finances
now rather than facing them in 2012.


12. (SBU) The bill heading for adoption does not levy taxes
food and medicine or cut back on generous special tax
regimes, and it is not the bold reform many had hoped for.
It is a step forward, however, and will help reduce pressure
on public finances, channel resources to the federal
government's priorities, and give Calderon more credibility
regarding his power to achieve political consensus. However,
a second generation of reforms will be needed to address the
expected 3.3 percent of GDP deficit in 2012 and channel more
resources to social development, infrastructure, and
sustained growth. End Comment.


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