Cablegate: The Gom's 2010 Revenue Proposal

DE RUEHME #2832/01 2731540
R 301540Z SEP 09




E.O. 12958: N/A

B. MEXICO 2537
C. MEXICO 2709

1. (SBU) Summary. Fiscal reform has become a critical element
in addressing the GOM's 2010 budget shortfall, resulting from
plunging revenues (due to falling oil production/prices and
economic recession), and public expenditure that grew in
tandem with skyrocketing oil prices from 2002-08 (see
reftels). On September 8, the GOM submitted to Congress the
2010 economic bill, which contains proposals to amend the tax
laws. The most important tax proposals are:
- Increasing the corporate and maximum individual income
tax rate from 28 to 30%, and imposing limits on companies
filing consolidated returns;
- Eliminating the flat tax &loss credit8 against income
tax due in the same fiscal year;
- Increasing the tax on cash deposits and lower the
exemption cap;
- Introducing a new contribution similar to the VAT to
combat poverty that would tax all activities at 2%; and
- Significantly increasing the excise tax on specific
goods and services.

The GOM's economic package has been criticized for largely
focusing on attaining short-term fiscal stability for the
purpose of preventing a downgrade from the rating agencies
(see reftel C). It achieves this stability through regressive
taxes and other measures that hurt the country's
competitiveness. End Summary.

Overview of Mexico's Revenue Structure

2.(U) Mexico's revenue structure can be divided into 3 broad
categories: tax, nontax, and public enterprise revenues.
The later consists basically of revenues from Pemex, the oil
company; CFE, the electricity company; and IMSS, the Social
Security Institute. Nontax revenue is mostly related to oil
exports on which the government collects a hefty percentage
through a &royalty8 that is not considered a tax.

3. (U) Tax revenue on its own represents approximately 10% of
GDP, which ranks Mexico among the lowest in the world. This
consists of income tax, 48% of the total; value added tax
(VAT), 38%; and special taxes on products and services
(IEPS), 6%; and all other taxes, 8%. (Note: Because of
loopholes, deductions, and exemptions associated with the
income tax (ISR), the GOM in 2008 introduced the corporate
flax tax (IETU) of 17% minimum. In 2008, the traditional ISR
collected 4.6% (including individuals) of GDP and the IETU
registered an additional 0.4%. End Note.) Although the VAT
is 15%, the structure is full of exemptions and exceptions
such as food and medicine. As a result, the entire VAT
recollection accounts for only 3.8% of GDP, which points to a
very inefficient tax administration.

Tax Reforms

4. (U) On September 8, the GOM presented its proposed revenue
package to Congress with significant tax law changes. The tax
reform includes permanent and temporary tax proposals to
increase both consumption and production taxes. These
proposals are subject to Congressional approval and changes
are likely prior to final approval. Primary taxes still
remain in effect, including income tax (ISR), flat tax
(IETU), the VAT, excise taxes and others. A summary and
commentary of the more significant proposed changes follow in
paragraphs 5 )15.

Consumption Taxes

5. (U) Anti-Poverty Tax (Anti-Poverty Contribution - CCP): A
new 2% sales tax similar to the VAT would be enacted to help
reduce poverty, and would have few exemptions, such as export

MEXICO 00002832 002 OF 005

sales. This tax would be creditable by businesses. While
value-added tax (VAT) remains unchanged at 15%, the proposed
sales tax would mean a 17% de facto rate, and cover all goods
and services, including many currently exempt from VAT
(particularly foodstuffs, medicines, and health services).

6. (SBU) Mexican economist Rogelio Ramirez de la O told
econoff that this tax was introduced as a &sales tax8
because PRI party statues forbid the approval of a &VAT8 on
food and medicine. Separately, Price Waterhouse Cooper
(PWC) analysts ) which, according to Econ sources,
participated in the pre-budget negotiations among the GOM,
PAN, and PRI ) said the idea behind the CCP is to gradually
(over the next few years) replace the VAT, which has many
exemptions. Some critics note that the tax will affect
economic drivers such as tourist services and call centers.
Comment: The GOM is essentially trying to enact a parallel
tax, as it did at the end of 2007 with a flat-rate business
tax, known as IETU, which is a parallel income tax without
existing exemptions and loopholes. End Comment.

7. (U) To justify the name of the tax as a contribution
against poverty, 36% is earmarked for an anti-poverty program
called &Oportunidades.8 This would represent an estimated
50% increase (from MX$47 to MX$74bn) in subsidies to poor
households through Oportunidades. There would also be an
additional 20% increase in the program Seguro Popular
(national health insurance), which provides limited medical
coverage with subsidized premiums. Seguro Popular is
administered by each of the states; federal resources are
transferred to the states through the National Health System,
the Mexican Social Security Institute (IMSS), or through
Oportunidades. (Comment: States receive over 90% of their
funds from the federal government. State finances are
generally perceived as lacking in adequate
oversight/accountability measures. End comment.)

8.(U) Excise taxes (Special Tax on Production and Services -
IEPS): The GOM is proposing an additional tax increase on
beer, alcohol, tobacco, telecommunications charges, and
gambling/lottery activities. While the demand on these
products in considered by some to be relatively
&inelastic,8 PWC analysts note that if the tax increases
beyond the equilibrium, more revenue will not necessarily be
generated and it could cause market distortions (i.e. black
markets, contraband).

9.(U) The GOM is also proposing a 4% tax on
telecommunications (except in rural areas). Telecoms,
considered to be one of the most important sectors for
increasing the country's competitiveness, will be hit hard
with the 4% IEPS plus the 2% CCP. The average telephone,
internet, and paid television user would pay a total of
MX$138 (approximately US$10) of tax per month for those
services; a sum equivalent to almost 3 days minimum wage
salary. Currently the average telcom user spends MX$758 (or
US$58) per month. The proposal would reduce new
infrastructure investment, drag on growth in mobile and
internet penetration, and disproportionately fall on low
income users.

Income Taxes

10.(U) Regular Income Tax Rates (ISR): The highest marginal
regular income tax rate (for corporations and individuals)
would temporarily increase from 28% to 30% for three years
(2010, 2011 and 2012), and would be reduced to 29% in the
fourth year (2013), finally scaling back to 28% in 2014. For
the primary sector (i.e. agriculture, cattle, etc.), the
maximum rate would increase from 19% to 22.5%. While many
other countries are reactivating their economies by cutting
corporate taxes in order to spur investment and employment,
the GOM is taking the opposite approach by proposing a
production tax increase. However, unlike other economies
with stronger fiscal systems, Mexico's tax revenues are very
low (10% of GDP) and there is a heavy dependence on oil
revenues (see reftels).

MEXICO 00002832 003 OF 005

11.(SBU) Minimum Flate-Rate Tax (IETU): This tax was part
of the fiscal reform passed in 2007. Because of loopholes,
deductions, and exemptions associated with the ISR, the GOM
introduced a minimum flat tax on businesses of 17%.
Currently, if a taxpayer generates a tax loss credit for IETU
purposes, the credit may be applied against the income tax of
the year. Though a rule included in the Federal Revenue Law,
deductions and credits would not be allowed in the same year.
This provision would only apply for 2010 unless enacted again
in future years. There is also a concern for U.S. companies
operating in Mexico that the U.S. will no longer recognize
and credit the IETU, so U.S. companies will end-up having to
pay double taxes.

12. (U) Tax Consolidation Regime (TCR): Significant changes
would be made to the TCR. Although qualifying taxpayers
would continue to be allowed to offset losses against profits
of other entities within a consolidated group and to
distribute dividends tax-free between group members, the
following changes are proposed:

-- 60% of any deferred income tax would have to be paid in
the fifth year following the year in which such losses were
offset or dividends paid, with the balance of 40% to be paid
in equal amounts over the subsequent 4-year period. This
provision would be applicable for all prior fiscal years
under tax consolidation (current rules allow deferral until
certain deconsolidation events take place). Thus, if this
amendment is passed, 60% of separate company unamortized tax
losses generated in 2004 and in prior years would be
triggered in 2010. These new recapture rules would also apply
to deferred taxes on intercompany dividends within the
consolidated group and other similar consolidation benefits.
-- A group would be deemed deconsolidated if the deferred tax
was not paid.
-- An independent auditor would be required to review and
certify the calculation and payment of the deferred tax.

13.(U) Under this proposal, the GOM expects to collect
MX$27.6bn, which is 16% of the total amount that the GOM
expects to collect from all taxes or the whole reform. While
the business sector is unhappy with the increase in the
corporate income tax, they are especially concerned about the
reform in the consolidation regime. They complain that the
changes do not give legal certainty to investors and are an
excessive fiscal burden particularly for exporters.

Financial Services

14. (U) Tax on Cash Deposits (IDE): The tax on cash deposits
would be increased from the current rate of 2% to 3%, and the
monthly limit on the aggregate tax-free cash deposits would
be reduced from a current floor of MX$25,000 to MX$15,000.
Fortunately, the IDE would still be creditable against other
taxes. Last year, IDE collected MX$17bn.

Other Noteworthy Measures

15.(U) Other significant and/or controversial
revenue-generating measures include:

-- Terminating the freezing of energy prices, which will be
reflected in a steady monthly increase. In gasoline, the
price would jump by 17.1% in 2010. It is worth noting that a
similar increase was responsible for the pick up in inflation
in 2008. Comment: Most analysts would revise their 2010
inflation projections upward (near 5%) under this fiscal
reform plan. End Comment.

-- Giving the Tax Administration System (SAT) the authority
to freeze taxpayers, bank accounts whenever money is due to
the Finance Secretariat and also allowing them to collect
what is due from those accounts.

Analysts, Impressions

MEXICO 00002832 004 OF 005


16.(SBU) Dr. Jose Luis de la Cruz, an economist at Monterrey
Tech (ITESM) told econoffs that the tax proposals aim to
recover the fall of budget revenue but there is no clear
long-term policy that will increase growth and
competitiveness. He also noted that the budget maintains the
same current expenditures while lowering investment.
Similarly, other analysts we spoke to say the GOM's fiscal
reform will have a short-term collection effect, but lacks a
long-term strategy to make everyone pay taxes. (Note: The
total number of taxpayers is 9 million; the total number of
companies paying taxes is 600,000, whereas the informal
sector reaches 12 million in a population of 105 million
inhabitants. End Note.)

17. (SBU) Moreover, the projected cuts in spending and
increases in tax revenue satisfy the immediate cash needs of
the GOM, but only at the cost of accentuating the recession
by weakening consumer demand. PWC analysts note that the
income tax increase for individuals will have a higher impact
on the medium and upper classes since their net income will
be reduced by -2.11% for those earning MX$60,000 a month,
-1.49% for those earning MX$25,000, and -1.07% for those
making MX$13,000. Discouraging consumption in effect hurts
sales of companies and employment. Unemployment in Mexico is
already at 6.25% -- its highest level in 13 years ) and the
2008 poverty rate is 47.4%, up from 42.6% in 2006. While
some of the negative effects will be offset through
Oportunidades grants to low-income households, other
households (i.e. the middle class) will suffer a negative
impact additional to the loss in disposable income from job
losses, reductions in nominal wages, and price increases.
(Note: Mexico's official definition of unemployment leads to
an underestimate of the jobless, because it excludes some
persons who could be counted as unemployed under the U.S.
concept. Moreover, it masks a large number of persons in
unstable marginal jobs. End Note.)

18. (U) The Mexican Competitiveness Institute (IMCO) also
criticized the tax reform for raising the cost of production,
which will have a negative impact on competitiveness. IMCO
recommends instead a general consumption tax and making
transfers to vulnerable groups so that they are not affected
by the tax (as it is regressive).

Opposition Response

19. (SBU) Although some observers believe the economic
package was pre-negotiated between the GOM and the leadership
of the PRI, many perceive the rank and file of the PRI as
reluctant to pass significant tax increases or subsidy
reductions. At the same time, the PRI wants to be seen as a
responsible opposition and they know something has to be done
to improve the country's public finances so they do not
inherit the same problems if/when they come to power in 2012.
The 2% sales tax is clearly the toughest political battle.
While the PRI and the PRD have made alot of noise opposing a
new tax, the PRI might vote in favor of it if food and
medicines are excluded. On September 23, PRI Senate leader
Manlio Fabio Beltrones said the discussion lies not on the
income part (new/increased taxes) but how the new revenue
will be spent to create more jobs. Hence, much of the noise
against the new taxes may just be &theatrics8 so that
Calderon and the PAN absorb the political cost of the reform.

20. (U) The PRI has also circulated alternative/supplemental
proposals. The most noteworthy include:

-- Eliminating some of the tax exemptions included in the
current VAT, such as education, transportation, books, etc.
(without touching food and medicine).

-- Instead of increasing the income tax (ISR) and approving
the 2% CCP, the PRI has proposed a revision/elimination of
the 200 existing loopholes in the ISR. Comment: This would
be politically difficult given the various interest and

MEXICO 00002832 005 OF 005

business groups that benefit from these special regimes. End

-- Amending the Federal Royalty Law: A PRI lawmaker from
Guanajuato introduced an initiative to levy mining
extractions and exploitation with a 4% tax on metallic and
non-metallic products. The revenue collected will go to the
states: 20% to the &Fondo General de Participaciones8; 80%
to a fund for the states where the mines are located.
Analysts at Price Waterhouse think both the PRI and the GOM
will approve this measure, despite the precarious situation
of the mining sector.


21.(SBU) The GOM's economic package has been criticized for
largely focusing on attaining short-term fiscal stability for
the purpose of preventing a downgrade from the rating
agencies (see reftel C). It achieves this stability through
regressive taxes rather than taking on larger structural
deficiencies like trying to eliminate special regimes
(loopholes, subsidies) which currently represent an estimated
3.9 percentage points of GDP in forgone revenue. This,
however, would be a larger political battle than proposing
new/increased taxes given all the vested interests that
currently benefit from these special tax regimes. The
reforms also reduce Mexico's competitiveness by increasing
the cost of production. In short, the GOM has opted to
balance the budgets on the backs of SMEs and the
middle-class, rather than confront monopolies and major

22. (SBU) At the same time, given Mexico's history and bad
experience with large foreign debt, deficits, and economic
crisis, the GOM is taking the orthodox approach of preserving
macroeconomic stability. Unlike other developed economies,
Mexico still has significant contingent liabilities that make
it difficult to increase the public deficit and debt.
Currently, total accumulated public borrowing requirements
total 40% of GDP. (Note: De la Cruz told econoffs that if
we take into consideration past pension regimes before the
reforms of the Mexican Social Security Institute (IMSS, 2005)
and Security and Social Services for Government Employees
(ISSSTE, 2007), as well as the states and other government
parastatals, the broad debt would amount to 100% of GDP. End

23. At the same time, if the GOM fails to get its tax
proposal through Congress and expenditures remain constant,
the GOM will face a fiscal gap for 2010 and may have to
resort to incurring more debt. There is no clear indication
that the GOM has an alternative to its tax proposal.
Meanwhile Secretary of Finance Agustin Carstens is pressing
states to pursue their own funds through property tax
collection; a clear strategy remains to be seen on this front
as well.

24.(U) This cable focuses on the revenue side of the GOM's
2010 Economic Plan. A separate report will follow on the
expenditure component.
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