September 8, 2013 / 9:33 PM / in 4 years

Mexico dilutes fiscal reform as plan dodges sales tax

Mexico's President Enrique Pena Nieto attends the first working session of the G20 Summit in Constantine Palace in Strelna near St. Petersburg, September 5, 2013. REUTERS/Sergei Karpukhin

MEXICO CITY (Reuters) - Mexico aims to increase taxes on higher earners, levy a charge on stock market gains and scrap loopholes, according to a draft of the government’s fiscal reform, but it has retreated from widening sales tax amid an economic slowdown.

Applying sales tax to food and medicine is a political hot potato in Mexico, and its omission will dilute the impact of the President Enrique Pena Nieto’s reform because it was seen as one of the most effective ways of raising more revenue.

Avoiding that levy, which senior figures in the ruling Institutional Revolutionary Party (PRI) had said looked almost certain, should help take the sting out of street protests led by the left, who say it would be unfair on the millions of poor.

It means much of the social burden for the reform will fall on the middle class, with the top rate of tax rising to 32 percent from 30 percent for those who earn more than 500,000 pesos ($37,800) a year, the draft seen by Reuters showed.

That sparked immediate criticism from the opposition conservative National Action Party, which Pena Nieto has been relying on for support to push through his economic agenda in Congress, where the PRI lacks a majority.

“To put this rate on those earning 500,000 pesos a month is an attack on the middle class,” said PAN Senator Francisco Dominguez, who sits on the Senate’s finance committee, adding he would not in principle support the bill.

By contrast, the plan, which also includes measures to tax soft drinks, was hailed by Mexico’s main leftist party.

The reform aims to increase Mexico’s weak tax revenues by nearly 3 percent of gross domestic product (GDP) by 2018 - less than the 4 percent of GDP several senior officials in the PRI had said the government was originally targeting.

The reform also backs off from imposing much higher income tax rates on Mexico’s top earners, including Carlos Slim, who started the year as the world’s richest man.

Instead, following a surprise contraction in the economy during the April-June period, the government plans to deliver a short-term boost to the growth with “emergency” spending which will cause a budget deficit this year and next, the draft said.

The bill proposes a “transitory” deficit of 0 to 0.4 percent of GDP for 2013, and 1.5 percent of GDP in 2014.

The government is set to unveil the reform later on Sunday.

STOCK MARKET TAX

Fiscal reform is one of the key planks of President Enrique Pena Nieto’s economic agenda, which aims to improve years of sluggish growth in Latin America’s No. 2 economy.

The reform proposes imposing a 10 percent tax on stock market gains and dividends and eliminating some two-thirds of special tax breaks and exemptions, the draft says. The shared border area with the United States will no longer enjoy a lower sales tax that was originally introduced to help spur trade.

Pena Nieto has pledged to lift growth to around 6 percent a year - up from an average of barely 2 percent since 2000 - by also opening up the oil sector to foreign capital, fomenting competition in major industries and improving education.

The reform proposes reducing the tax burden on state oil monopoly Pemex PEMX.UL to below 60 percent, from 79 percent. That interlocks with a separate energy reform Pena Nieto has presented which seeks to lure foreign investment into the industry to help reverse a slide in crude production.

The government wants to wean itself off dependence on tax revenue from Pemex, which it currently relies on to fund around a third of the federal budget. Easing the crushing tax burden on the company should help it to compete better internationally.

Mexico has the lowest tax revenue in the 34-nation Organization for Economic Co-operation and Development (OECD), crimping its ability to spend on health, infrastructure and social programs vital to boosting living standards and growth.

Excluding revenues from Pemex, the total of taxes raised by the government was only 9.7 percent of GDP in 2012.

ECONOMIC WOES

The government slashed its 2013 growth outlook to 1.8 percent last month after the economy shrank by 0.7 percent in the April-June period. That increased pressure on policymakers to hold back from any measures that could crimp demand.

The proposed reform will include a universal pension and other measures to help the poor in Mexico, who account for nearly half of the population. It also details various measures that aim to help formalize the vast informal economy.

The government also aims to levy so-called health taxes, including levies on fuels and soda pop, to combat obesity. It would also continue to erase fuel subsidies, and gasoline prices would rise in line with inflation from 2014.

Shortly after taking office in December, Pena Nieto forged a pact with the opposition to push for a range of reforms. It has helped him push major legislation to increase competition in the telecoms sector and improve education standards.

Pena Nieto is already grappling with protests by teachers opposed to tougher standards, causing friction between the PRI and the leftist Party of Democratic Revolution (PRD), whose leader Jesus Zambrano also signed the so-called Pact for Mexico.

Zambrano welcomed details of the tax reform on Sunday.

“It seems this would be a big step forward in re-directing the economic policy of Pena Nieto’s government,” he told Reuters. “It would mean paying heed to a fundamental part of the agreements contained within the Pact for Mexico.”

The PRD is opposed to Pena Nieto’s energy overhaul, arguing it plans to give away Mexico’s oil wealth. But agreement on the tax plan could bring the two sides closer together, possibly smoothing the passage of the energy bill through Congress.

Still, Mexico’s most well-known leftist, Andres Manuel Lopez Obrador, the runner-up to Pena Nieto in last year’s election, has vowed protests against the reforms.

Thousands gathered at a rally led by Lopez Obrador in central Mexico City on Sunday, though the atmosphere was peaceful. In 2006, his protests over alleged electoral fraud paralyzed parts of Mexico City for weeks.

($1 = 13.2405 Mexican pesos)

With reporting by Alexandra Alper, Miguel Gutierrez, Anahi Rama, Ana Isabel Martinez, Simon gardner, Michael O'Boyle and Gabriel Stargardter; Editing by Kieran Murray, Nick Zieminski and Diane Craft

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