MEXICAN CONGRESS APPROVES LONG-SOUGHT TAX REFORM

UNCLAS SECTION 01 OF 04 MEXICO 005044

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, ANNA JEWEL)
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: MEXICAN CONGRESS APPROVES LONG-SOUGHT TAX REFORM

REF: A. MEXICO 4970

B. MEXICO 4815

C. MEXICO 4552

D. MEXICO 4282

E. MEXICO 4280

F. MEXICO 4236

G. MEXICO 4191

H. MEXICO 4151

I. MEXICO 4015

J. MEXICO 3246

K. MONTERREY 725


1. (SBU) SUMMARY: Mexico's Senate approved an overhaul of
the country's tax laws on September 14 -- a move that will
strengthen public finances and give President Calderon
another legislative victory. The Chamber of Deputies has
already approved the bill, so most of the reforms only
require the Executive's signature to be published in the
Official Gazette and become law. The reform introduces an
alternative minimum corporate tax, creates a tax on cash
deposits, increases the gasoline tax by 5.5%, and enacts some
measures to strengthen tax collection. The reform will boost
government revenues by 1.1% of GDP in 2008, a figure that
gradually increases to 2.1% of GDP by 2012. While the scope
of the reform is limited, it is a step in the right direction
and it sends a positive signal regarding Calderon's ability
to pass other economic reforms. END SUMMARY.


2. (U) Mexico's Senate approved an overhaul of the country's
tax laws on September 14 -- a move that will strengthen
public finances and give President Calderon another
legislative victory. The Chamber of Deputies has already
approved the bill, so most of the reforms only require the
Executive's signature to be published in the Official Gazette
and become law. A few measures related to the supervision of
public accounts must pass through state legislatures since
they entail changes to the constitution.


3. (U) Under Secretary of Finance Alejandro Werner remarked
publicly that the reform will have a direct impact on public
finances and will promote greater economic growth.
Government officials expect the measures to increase real GDP
growth in 2008 from 3.5% to 3.7%. Werner added that the
passage of the bill sends clear signals to domestic and
foreign investors that Mexico has begun to work on a more
solid and competitive economy. Werner added that the bill
opens the door for movement on labor, energy, and educational
reform.


4. (U) The reform will boost government revenues by 1.1% of
GDP in 2008, a figure that gradually increases to 2.1% of GDP
by 2012 (vs. 1.5% and 2.8%, respectively, in the original tax
proposal). Note that these figures do not include the
effects of a tax hike on gasoline or a tax cut for Pemex.
When a new tax on gasoline is excluded, approximately 70% of
the additional resources will go to the federal government
and 30% to the federal entities. Calderon has pledged to use
the extra federal resources for infrastructure, education,
and health programs.

--------------
Key Components of the Bill
--------------


5. (SBU) Large parts of the reform proposal the
administration unveiled in June remained intact, but the
government was forced to make a number of concessions to
appease business and interest groups to secure backing from
the opposition. Some of these changes watered down the bill,
while others were improvements.

Public Revenues
--------------

MEXICO 00005044 002 OF 004




6. (SBU) The heart of the bill is an alternative minimum tax
called the Single Rate Corporate Tax (IETU for its initials
in Spanish),which is intended to respond to criticism of
loopholes companies in Mexico use to significantly lower
their tax bill. Werner has said publicly that congressional
changes to this tax have made it more "friendlQo
investment. The tax, which allows fewer deductions than the
regular income tax, will be set at 16.5% next year and will
rise to 17% in 2009 and 17.5% in 2010 (vs. 19% in 2010 in the
original proposal). Salaries will generally be creditable
under the IETU, and employee benefits will generally be
deductible. New investments made in the fourth quarter of
this year will be deductible over the next three years. For
investments in fixed assets, deferred expenses and charges,
the bill grants a tax credit against the IETU at a rate of 5%
during the next 10 years. The proposal also allows tax
deductions for charitable donations (with some restrictions)
as well as deductions for private schools and small
agricultural producers. According to the Department of
Treasury's Tax Policy Office, the USG and GOM have been in
discussions regarding the creditability of the IETU against
U.S. income taxes but have not made any public announcement.


7. (SBU) A 20% excise tax (IEPS) on gambling and lotteries
was approved, while a proposed tax on aerosol paints was
rebuffed. The bill repeals the Assets Tax (IMPAC),and
removes tax exemptions on stock sales that involve a change
of control of a company, or the sale of more than 10% of a
company's stock in a 12-month period. Mexican Stock Exchange
Deputy Director General Pedro Zorrilla said publicly that the
change will not inhibit investment, noting that the benefits
of financing through the stock market will offset any
negative impact. Edgar Camargo, the Head of Economic
Research at Bank of America in Mexico (strictly protect
throughout),told econoff that while at first glance this
change may raise concerns, it "is not a big deal" since it
only affects "very large amounts of money." Referencing the
mergers of BBVA and Bancomer and Citibank and Banamex, he
said the government is trying to avoid large transactions
taking place tax free.

Tax Cut for Pemex
--------------


8. (U) Legislators also approved measures that will free up
more cash for Pemex to invest to stem declining oil
production. The rate on the ordinary fee on hydrocarbons is
reduced from 79% currently to 74% in 2008, and it falls to
71.5% by 2012. The move cuts USD 2.7 billion from Pemex's
tax bill in 2008 and USD 5 billion by 2012. The reform
boosts the amount of resources dedicated to scientific and
technological research, and it requires Pemex to carry out a
program to increase its operational efficiency, following
approval from the Secretariat of Energy.


9. (SBU) Camargo remarked that the PRI pushed for these
measures because it wanted to make sure Pemex received a part
of the additional resources from the tax reform and because
it wanted to strengthen its links to one of the country's
most important unions. He remarked that he was not
particularly pleased with the initiative, but that he would
wait and see if Pemex spent the money wisely. Hacienda
officials on several occasions have told econoffs that they
wanted to improve Pemex's efficiency and transparency before
giving the company more resources.


10. (SBU) That said, many industry analysts argue that the
measures provide much-needed tax relief since Pemex's high
tax bill leaves it with little to devote to exploration and
refining. Mexico already imports 40% of its refined oil
products, and its oil reserves are expected to fall over the
next decade.

MEXICO 00005044 003 OF 004



Tax Administration
--------------


11. (U) The bill levies a 2% tax on cash deposits exceeding
25,000 pesos (USD 2,294) per month, an attempt to attack tax
evasion in Mexico's vast informal economy. This "Tax on Cash
Deposits" is creditable against the income tax and other
federal contributions. It will become effective on July 1,
2008 to give banks time to prepare their systems to collect
the tax. Most remittances as well as payments made in cash
to repay loans granted by financial institutions are not
subject to the tax.


12. (U) The majority of Calderon's proposals to strengthen
auditing and control procedures were approved. In
particular, Congress is given more power to audit federal
transfers to the states; fines to advisors and service
providers are increased; shared responsibility is established
when a firm changes its address without proper notice; and
new rules are established regarding a taxpayer's obligation
to provide authorities documentation during an audit.

Fiscal Federalism
--------------


13. (U) The bill enacts a 5.5% increase on federal gasoline
and diesel taxes, the proceeds of which will go to state and
municipal governments for investment in infrastructure
projects. The planned rate hikes will be implemented over an
18-month period. This tax is transitory and will be
suspended if a (failed) proposal that would have allowed
federal entities to levy products subject to the federal
excise tax (IEPS) is approved at the local level, and any
state incorporates the local sales tax. HSBC economist
Alejandro Martinez (strictly protect throughout) told econoff
the reform package "does almost nothing" to improve fiscal
responsibility and transparency at the state level. He added
that the states were the biggest winners of this reform
because they secured additional income without having to
assume the political costs of raising taxes.


14. (U) The bill creates two funds: the Hydrocarbon
Extraction Fund for states where oil is extracted, and the
Compensation Fund for the 10 states with the lowest
non-mining and non-oil related GDP per capita. The latter,
which aims to direct resources to the poorest states, will be
financed with approximately 20% of the revenues from the new
gasoline tax.

Public Spending
--------------


15. (U) The bill stipulates that the Executive Branch must
reduce its operating and administrative expenditures by 5%
per year in coming years, with a final goal of trimming 20%.
In lieu of creating a National Council of Public Policy
Evaluation, the bill established general principals that will
be the basis of performance evaluations made by public
institutions that have this function. The reform also
requires government-owned companies to create "austerity
programs," and it promotes greater competition in government
acquisitions.


16. (U) It is worth noting that a few measures regarding the
supervision of public accounts entail changes in the
constitution, and therefore must be approved by local
legislatures. The Chamber has approved these measures, but
the Senate has yet to ratify them.

--------------
Reaction to the Bill
--------------

MEXICO 00005044 004 OF 004




17. (SBU) Some local pundits have highlighted the many
concessions the government made to secure the opposition's
backing for this reform. They note that the final reform
bill is "too little" and that it came at too high a price.
Alejandro Martinez remarked that market followers are already
asking how much Calderon will have to concede to secure
passage of more difficult initiatives, such as energy reform.
Some business leaders continue to argue that the new
measures will hurt investment and economic growth.


18. (SBU) Most market observers, however, agree that while
the reform is limited, it is a step in the right direction.
Camargo told econoff the reform sends a positive signal
regarding Calderon's ability to govern and pass other
economic reforms down the road. He underscored that it was
not simply the passage of the reform, but rather the fact
that Calderon was able to advance his agenda while working
with the opposition in Congress. From his point-of-view, it
is better to have passed a slightly less ambitious reform
that kept "the channels of communication open," than to have
secured approval of the government's initial proposal but
left severe divisions among political parties.


19. (SBU) Camargo told econoff that the reform will probably
lead Standard & Poor's to upgrade Mexico's sovereign rating
by yearend. He noted that other factors, including the heat
rating agencies have taken for not warning about trouble in
the sub-prime market, could delay the expected outcome.
While an upgrade would not result in a huge market rally, it
would be welcome news to financial markets. Martinez was
slightly less optimistic, noting that he expected the upgrade
in early 2008.

--------------
Comment
--------------


20. (SBU) The tax reform bill should be seen for what it is,
a first step forward. The approval of this reform represents
another victory in Congress for Calderon and an important
step for a country that has not approved any significant tax
reform measures in a decade. Importantly, the reform will
help Calderon address falling oil production and keep pace
with rising health and pension commitments as Mexico's
population ages. This reform opens the way for the
administration to push other much-needed initiatives, such as
streamlining its cumbersome legal system, improving its
educational system, and undertaking labor and energy reform.
End Comment.


Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
GARZA