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Cablegate: Senate Takes Up 2010, with Senators Divided Over Proposed

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RR RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #3110/01 3020011
ZNR UUUUU ZZH
R 290011Z OCT 09
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 8820
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE

UNCLAS SECTION 01 OF 03 MEXICO 003110

SIPDIS
SENSITIVE

STATE FOR WHA/MEX, WHA/EPSC, EEB
NSC FOR RESTREPO, FROMAN
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD
TREASURY FOR NANCY LEE, IA
ENERGY FOR WARD, LOCKWOOD AND DAVIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD ENRG ELTN EAIR PGOV SENV MX

SUBJECT: SENATE TAKES UP 2010, WITH SENATORS DIVIDED OVER PROPOSED
TAX INCREASES; A DEBT DOWNGRADE HANGS IN THE BALANCE

REF: MEXICO 2832

1. (SBU) Summary. As rating companies quietly consider downgrading
Mexican debt, the Senate has now noisily taken up the Revenue Bill
that the Chamber of Deputies amended and approved October 20. The
Chamber had watered down the GOM's original proposal of modifying
tax rates and tax laws designed to strengthen public finances and
avert a credit rating downgrade. The Chamber scrapped the GOM's
proposed 2% anti-poverty sales tax, but increased the VAT by 1% (to
16% and 11% at the border), keeping a zero rate for food and
medicine. The Chamber also approved raising income taxes to 30%, up
from 28%. Although the arithmetic of the Chamber's version covers
the fiscal gap anticipated for 2010, it is significantly weaker and
more ad-hoc than the GOM's proposal. It is doubtful that the
measures are strong enough to avoid a ratings downgrade as this
version stops short of providing a long-term solution to falling
public revenue and will not help generate alternative income sources
to replace the GOM's dependence on oil. The Senate has until
October 31 to approve the revenue bill. End Summary.

2. (SBU) The Revenue Bill must now be approved by the Senate by
October 31. After the bill was amended and approved in the Chamber,
the consensus view was that the Senate was not going to introduce
any significant modifications to the proposal. However, PRI senators
rebelled against the tax package. The origin of the problem may be
the attempt of PAN legislators - mainly PAN federal deputy and party
president Cesar Nava - to blame the PRI for the VAT increase
proposed in the lower house. Mexican economist Rogelio Ramirez de
la O told Econoff that he believed 60% of the Senate's political
complaints and threats were theatrics (towards the 2012 presidential
elections) and 40% were real. At the end of the day what we will
probably see are some modification/dilution to the Chamber's bill as
has always been the case in past years. This year, however, the
stakes are higher and the PRI - particularly the governors -- stand
to lose more by further diluting the pending tax reforms.

---------------------
The Chamber's Version
---------------------
3.(U) On October 20, the Chamber of Deputies amended and approved
the GOM's 2010 Revenue Bill. To gain the needed support from the
opposition PRI, the GOM had to accept several changes in its tax
package and income assumptions. The approved legislation forecasts
MX$3.18 trillion (US$244 billion) in total revenue, slightly more
than the GOM's original proposal. It calls for a wider deficit next
year of 0.75 percent of GDP, compared with 0.5 percent in the GOM's
proposal. It also increases estimated revenue by raising the
benchmark oil price to US$59/barrel from US$53.90. The main
elements of the approved tax package follow below.
1% VAT Increase
---------------

4. (U) The general VAT will increase from 15 to 16% (and from 10% to
11% at the border). Food and medicine will remain at 0%. The
legislation scraps the GOM's proposed 2% anti-poverty tax to all
goods. According to Goldman Sachs, this change is expected to
generate MX$34 billion (vs. MX$72 billion expected from the 2%
anti-poverty tax).

Tax on Telcom Reduced
---------------------

5. (U) The special tax (IEPS) on telecommunications was cut to 3%
(from the GOM's proposed 4%). The tax hits fixed and mobile phones,
pay-TV, and internet. Exempted from the tax are rural fixed-line
telephones, public telephones, and intermediary, inter-connection
charges (though end-users will sill be taxed). NOTE: Scattered
press reports suggested that mobile calls would not be taxed.
However, the "dictamen" and Secretariat of Communications and
Transportation (SCT) contacts indicate mobile is not exempt. END
NOTE. The VAT increase also applies, so the total tax hike to
telecom is 4%.

6. (SBU) The telecom industry has fiercely protested this tax
increase. They argue that telecom is an easy target as one of the
few profitable sectors in this year's recession. They note that
the 3% increase is regressive in that per-minute cell prices are
highest for the poorer users who buy pay-as-you-go minutes. It is
also likely to slow voice line penetration (currently 82% of
population has mobile, fixed or both) and new investment in

MEXICO 00003110 002 OF 003


infrastructure. Moreover, the tax includes a limited exception for
rural fixed lines, deemed a basic service. But since the fixed line
penetration rate in Mexico is less than 20%, the primary access path
for many basic/low income users is cellular. Additionally, there is
nascent protest across the internet, with many chat sites and
Twitter users decrying the telcom tax as a further impediment to
growing internet access, which is currently at an abysmally low
20-25% penetration across Mexico.

"Sin" Taxes
-----------

7. (U) The GOM's proposed IEPS increases on "sin" goods were also
lowered somewhat:
-- The tax on alcoholic beverages will increase to 53% (from the
current rate of 50%). (The GOM proposed to tax alcoholic beverages
at 3 pesos per liter.)
-- The tax on beer will be 26.5% for 2010-2012, will decrease to 26%
in 2013, and then return to the current rate of 25% in 2014. (The
GOM proposed an increase of 28% in 2010, 2011, 2012; and a reduction
to 27% in 2013; and a return to the current rate of 25% in 2014.)
-- Tobacco will be taxed at 0.10 pesos per 75 grams. (This is very
similar to the GOM's proposal of a 0.0533 peso per gram tax.)
-- The rate on bets and gambling was increased to 30% (from the
current rate of 20%). (Unchanged from the GOM's proposal.)

Income Tax (ISR)
----------------

8.(U) As proposed by the GOM, the highest marginal regular income
tax rate (for corporations and individuals) will 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.


Fiscal Consolidation Changes
----------------------------

9.(U) The GOM's proposed limitations on tax deferment by
conglomerates which use tax consolidation were reduced. Tax
consolidation is a legal tool used by holding firms in which profits
and losses of their entities are consolidated and taxes are paid on
the net result. The language in the current income tax law allows
these firms to deduct losses of one of their subsidiaries against
the profits of others. Currently, holding firms can defer tax
payments due to existing loopholes in the current tax income law.
In practice such firms were found to be deferring taxes
indefinitely. A recent Tax Administration Service (SAT) report
revealed that 4862 subsidiaries consolidated into 422 holding firms
and paid on average 1.78% (rather than the 28%) over their sales in
2008 (see reftel A). The GOM's proposal was limiting deferment to no
more than 5 years, so that firms would start in 2010 paying 60% of
taxes deferred in 2005 and the rest in 4 subsequent years in equal
parts. The lower Chamber amended the initial payment to 40% and the
rest in four parts of 15% each.

10.(U) The business sector is particularly concerned about the
changes to the tax consolidation regime. They complain that the
changes do not give legal certainty to investors and are an
excessive fiscal burden particularly for exporters. Mexico's
leading business consortium, the Consejo Coordinador Empresarial
(CCE) said it will file injunctions against the new tax
consolidation regime and appeal to the Supreme Court. Many of the
trade and business organizations are expected to lobby the Senate to
eliminate these changes.


New Tax for Pemex
-----------------

11. (U) Lawmakers also passed changes to tax rules for state-owned
oil company Pemex aimed at promoting investment at new fields.
Instead of applying different rates depending on the level of
production, they approved a flat rate. They also introduced a new
tax of 52% when the oil price exceeds 60 dollars per barrel. They
also eliminated the differentiated tax regime for the Chicontepec
wells (71.5%) and deep water projects (between 60-71.5%) and
replaced it with a flat rate of 30%, which will increase to 36%
whenever production exceeds 240 million barrels. The cap for

MEXICO 00003110 003 OF 003


deductions will also be increased to boost investment. The oil
extraction tax was also modified. The tax is currently 10% when the
price is below US$40 and 20% when it is above US$60. The new flat
rate is 15% on the value of oil and natural gas extracted in a year.
According to both the GOM and Congress, these changes will give
Pemex flexibility to invest more. (Note: The legislation did not
include an estimation of how much the 52% tax would generate. End
Note.)


Tax on Cash Deposits (IDE)
-------------------------
12.(U) The lower house approved the GOM's proposal to tax all cash
deposits of at least 15,000 pesos (in a month) at a rate of 3
percent. The tax is currently 2 percent and only applies to deposits
exceeding 25,000 pesos. The IDE will still be creditable against
other taxes.
---------------------------
Internal PRI Power Struggle
---------------------------

13.(SBU) There is also an internal PRI political power struggle in
the midst of the fiscal reform dispute. PRI senators are blaming
interference of three PRI governors (Mexico, Oaxaca, and Veracruz)
for putting pressure on the Senate to accept a tax package that
would benefit the states. In Mexican economist Rogelio Ramirez de la
O's view, the opposition is based on an internal party power
struggle between Senator Manlio Fabio Beltrones and PRI President
Beatriz Paredes. The rebels resent being left outside of an
agreement between the GOM, some PRI governors, and Paredes who drove
the decision to reach a compromise on taxes in the lower House. PRI
senators will drop their objections to a compromise if they are
included at the negotiating table for such agreements with the GOM.
Ramirez de la O, however, notes that PRI senators - in order to save
face - now need to further dilute the package. Paredes'
international affairs advisor, Fausto Zapata, told Charge that this
spat should be manageable, especially in light of what he termed
"the colossal ineptitude" of Cesar Nava. Nava's wrench in the works
has given the PRI the upper hand in the negotiations with the GOM
and that will likely produce PRI party unity.

14.(SBU) In addition, local businesses are lobbying the opposition
to lower taxes on telecom services and to further relax the changes
to the so-called "Fiscal Consolidation" rule. Some PRI senators are
proposing to bring the VAT rate back to 15%, to lower taxes on
telecom services, and to ease the fiscal consolidation rules. In
order to offset the revenue loss, these senators propose increasing
the projected oil price in next year's budget to $64/barrel and
raising the budget deficit to 1% of GDP. This proposal, however,
does not benefit the income transfers to the states. PRI members in
support of stronger tax reform measures are concerned about the
party's vulnerability in the ten state elections scheduled for next
year. The PRI stands to win in at least seven of them.

15. (U) Any changes in the Senate must go back to the Chamber for
approval. The lower Chamber now has until November 15 to approve the
expenditure side of the budget. (Note: The Senate has no vote on
the expenditure side. End Note.) President Calderon is unlikely to
veto the expenditure bill, as he does not have sufficient votes in
the Chamber of Deputies.

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

16. (SBU) The Chamber's version only covers the fiscal short-fall
anticipated for 2010 by increasing the oil price assumption,
incurring slightly more debt, and increasing taxes (but at lower
rates than the GOM initially proposed). It is doubtful that the
measures are strong enough to avoid a ratings downgrade, as they
stop short of providing a long-term solution to falling public
revenue and generating alternative income sources to replace the
GOM's dependence on oil. Political, intraparty, and personal
struggles in the Senate suggest further dilution of an already weak
revenue package, increasing this likelihood of a downgrade.
Observers have noted that in past years legislators have been given
to similar theatrics and posturing. However, this year, as Mexico
digs itself out of a recession and seeks to strengthen alternate
revenue sources, the stakes are considerably higher.

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