In recent weeks, there have been signals about an impending fiscal reform in Mexico. Early in March, the Lower House of Congress, controlled by the president’s party, announced the creation of a work group to analyze alternatives for a broad tax and expenditure reform. Some days later, president Andrés Manuel López Obrador –who has said that any tax changes would come during the second half of his six-year term– stated that a reform is needed but made clear it should not raise taxes or increase debt. A few days ago, Mexico’s Secretary of the Treasury Arturo Herrera pleaded not to politicize the issue and asked for a “technical” discussion on the matter. All this can only mean that the López Obrador government is thinking about it and that we can expect –as it often happens with taxes– a hard political battle. Here are five takeaways on how the landscape looks:
1. Taxes and economic recovery. The Mexican economy showed signs of weakness since the last quarter of 2018 and ended up with a slight drop of 0.1 percent in 2019. Then, it was badly hit by the Covid-19 pandemic to further contract a whopping 8.2 percent in 2020. Economic activity has undoubtedly begun to pick up and most estimates predict a healthy growth for 2021. The government’s own figure is 5.3 percent –close to the International Monetary Fund’s forecast of 5.0 percent. However, two things remain unclear: the extent to which the recovery will be sustainable as opposed to just a technical rebound, and the time it will take to reach pre-pandemic levels. According to Mexico’s statistics agency (INEGI), private consumption last January was still at May 2016 levels, while physical investment merely reached July 2010 levels. Moreover, foreign direct investment decreased by 11.7 percent last year. Given present conditions, it will be a hard to sell both Mexican voters and businesses alike that Mexico can tax its way out of recession.
2. Increasing expenditure pressures. To the surprise of many, in some respects, Mr. López Obrador has turned out to be quite a fiscal hawk. As a recent Wall Street Journal article by Santiago Pérez and Anthony Harrup points out: “Mexico’s stimulus, either additional spending or tax breaks, ranks at the bottom of the Group of 20 nations at just 0.6% of gross domestic product, according to estimates from the IMF”. Also, president López Obrador has embarked on an impressive series of budget cuts of what he believes is fraud, waste, and abuse. However, the other side of the coin is that the resources made available to him have gone into priorities which raise many concerns. These include rescuing PEMEX and CFE (Mexico’s state-owned energy firms), funding signature infrastructure projects (including a new oil refinery that experts see as an awfully bad idea) and a series of cash-transfer programs to different social groups. Funding these priorities has been possible thanks to the budget cuts, but also because of one-time revenue sources that are pretty much gone. Sustaining these decisions looks iffy at best. To take one example, the president lowered the retirement age for a public funded pension program from 68 to 65 years while increasing the individual benefit. Just this move could cost Mexico an additional 2 percent of GDP between 2020 and 2024, according to some estimates.
3. Fiscal federalism. Mexico has a highly centralized tax system by which most taxes are levied at the national level, with Mexican states and municipalities relying on a vast and complex system of revenue sharing and grant transfers. For the last 20 years, calls for greater fiscal autonomy from subnational governments have largely been solved by transferring a “bigger piece of the pie” to them, rather than gradually building a local tax base. For example, property tax in Mexico amounts to roughly 0.4 percent despite the fact that the international average is around 2 percent and that property tax is regarded as a good revenue source for subnational governments. In general, state and municipal governments in Mexico have preferred to avoid the political cost of raising taxes, while the federal government seems to have enjoyed “managing the checkbook”. Every single tax and expenditure reform in Mexico of the past 50 years has resulted in a fierce fight for the intergovernmental distribution of public money, regardless of the size of it and the political colors of those involved. Given the current rift between most opposition state governors and president López Obrador -not the highly politically polarized environment-, we can expect that any future reform will not be an exception to this rule.
4. Progressive taxing. One can hardly doubt president López Obrador’s genuine intent to improve the lives of Mexico’s poor and the socially marginalized even if one adamantly opposes the way he seeks to achieve this. He has often stated that “for the benefit of all, we must work first for the poor”. Relations between the private sector and government have been rough over the last years, and in fact some would argue that López Obrador often polarizes on social or economic terms to serve his own political agenda. It is also true that the president has frequently talked about the need for private investment to hep developing the country. In this context, and with a business climate that many argue has deteriorated, it is hard to see a reform that could successfully balance the sort of progressive taxation we can expect from AMLO, with the need to really stimulate private investment.
5. Political context. Much is at stake on Mexico’s next June’s midterm election, including the control of the Lower House of Congress which has exclusive right to discuss and vote on the annual budget. Furthermore, the Mexican Constitution mandates that the House must look and vote on any tax bill that is presented before the Senate does. Polls currently suggest that president López Obrador’s party (MORENA) will retain its legislative majority. However, the numbers have been closing recently and there is still a large number of undecided Mexican voters. Should MORENA lose the Lower House in June, president López Obrador’s maneuvering room on tax and spending matters would be significantly reduced. It would also affect the prospect of the president pushing tax reform during a lame-duck session of Congress should he call for one.
*Gerónimo Gutiérrez Fernández is senior advisor at Covington and Burling, LLP and partner at BEEL Infrastructure. Twitter: @GERONIMO_GF