Peña Nieto’s fiscal reform and the consolidation of the Grand Bargain-The Expert Take

Expert TakeBy Duncan Wood

On the evening of Sunday September8th, President Enrique Peña Nieto announced his government’s much awaited fiscal reform package, which he had sent to the nation’s congress earlier that day. To the surprise of many, the proposal was ambitious, far-reaching and opted not to apply the national sales tax (IVA) to food and medicine, which had been seen by many as the only viable option available for raising tax revenue for the government. Mexico suffers from one of the lowest tax takes of all the OECD countries, with non-oil tax revenue reaching only 12-13% of GDP. Even when combined with substantial monies collected from the national oil company, Pemex, government revenue in Mexico has only been able to reach a paltry 19% of GDP.

The fiscal reform package laid out by the government is focused on increasing revenue, increasing government spending on social programs, and on forcing the wealthier elements of Mexican society to pay more taxes. The government has promised to provide universal social security and pension coverage, unemployment insurance, universal health care and increased spending on education. Each of these will be embodied in a constitutional reform. Pemex will also see a reduced tax rate, falling from 70% to 60%.

In order to pay for this increased spending, the government aims to raise revenue by adopting a multidimensional approach, including a simplified tax code for businesses, a capital gains tax applied to share dividends, the closing of tax loopholes and a majority of existing tax exemptions, and by raising the tax rate on individuals who earn more than 500,000 pesos ($37,800) a year from 30% to 32%. The president also committed to deficit spending in both 2013 (0.4% of GDP) and 2014 (1.5% of GDP), and emphasized the need to engage in counter-cyclical spending during economic slowdowns. The government has also introduced a proposal for a tax on sugary soft drinks, designed to help curb the country’s worrying obesity problem. The government hopes that the combination of these measures will raise tax revenue by nearly 3 percent of gross domestic product (GDP) by 2018.

The fiscal reform has a definite populist tone, by promising increased benefits, taxing the wealthy, and going after those who have not traditionally paid taxes. The government is already receiving criticism from the right of center PAN party, which claims that this is an attack on the middle class, the only group who regularly pays taxes in Mexico. The prospect of higher deficit spending is also worrying for fiscal conservatives who have speculated that the government risks creating inflationary tendencies in the economy.

But there is clearly a broader economic and political logic behind this. First, there is a real need to raise government revenue, and it has long been noted that Mexico’s wealthier citizens and corporations do not pay their fair share. By focusing on eliminating exemptions, the government will be able to bring in more revenue from those who have the capacity to pay, and whose contributions have been extremely low by international standards.

The political calculation may be more crucial, however. First, by refusing to apply the IVA to food and medicine, a move that would have been criticized as regressive and unjust and by focusing tax collection efforts on the wealthier elements of society, the government has eliminated one of the major complaints of Andres Manuel Lopez Obrador (AMLO) and the MORENA social movement, who recently accused the president of being “corrupt and a traitor”. Indeed, the disappointingly low numbers of protestors (thousands, as opposed to tens of thousands) who gathered earlier in the day to support AMLO in his campaign against the government’s reform agenda must have been seen as an encouraging sign by the government in advance of the unveiling of the fiscal reform. Moreover, by focusing on the concept of a “social reform” of the fiscal system, the government has been able to strengthen its cooperation through the Pacto por Mexico with the PRD, which was under increasing strain in the aftermath of the government’s proposal for energy reform. This will not only help to mitigate the left’s protests against the energy reform, but should also ensure that cooperation between the three parties continues beyond this Fall session of Congress. Cross-party unity was clearly displayed at the presentation of the fiscal reform, with the leaders of the Pacto por Mexico seated front and center on the podium.

A fascinating political balance is now emerging. On the issue of energy reform, the ruling PRI has clearly allied itself with the PAN, alienating the PRD. However, with this fiscal reform proposal, that appears highly progressive, the government has ensured that the PRD continues to work with the PRI and stays in the Pacto, which in turn increases the probability of future legislative success for the government.

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