Convention falls short: fiscal reform effort won't solve revenue problems.

Aug. 17 was supposed to be the signal day when Mexico's three-year fiscal reform impasse was resolved.

Governors, top legislators and President Vicente Fox gathered at the National Palace to give short, enthusiastic speeches about the six months of closed-door negotiations they had just completed.

But missing from their tributes to dialogue and understanding were details on how the consensus they had reached would significantly increase Mexico's paltry tax collection.

The reason was for this was that the talks--carried out under what was called the National Fiscal Reform Convention--had produced no such accord.

A thick pamphlet released after the day's last speech contained the news: nowhere among the convention's hundreds of fiscal proposals was there a measure that would substantially increase government revenue.

FISCAL UNDERACHIEVER

Mexico currently collects only 12 percent of gross domestic product (GDP) in taxes--one of the lowest percentages in the region. According to the convention's comparative analysis, Brazil takes in over 21 percent of GDP via taxes, the United States collects about 29 percent and Canada a whopping 39 percent.

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Without more revenue, economists say Mexico will be hard pressed to better prepare its workforce and improve its infrastructure--both vital for sustained economic growth.

At the convention's outset in February, Fox and the governors made clear they shared a common goal of boosting tax revenue.

The president's own tax-hike plans have floundered in the opposition-dominated Congress since he took office in December 2000, and the convention was seen as a chance to get revenue-hungry governors on board to pressure lawmakers into approving unpopular new taxes.

But somewhere along the way--and reportedly during the convention's final week--talks between federal and state officials on boosting revenue broke down.

The convention's working group on the issue--comprised of federal, state and local officials--in July unanimously approved a proposal to lower federal value-added tax (VAT) to 12 percent from 15 percent, while slapping VAT of four percent on currently exempt food items.

Under the group's proposal, states and municipalities in turn would split a three-percent sales tax, and states would also levy a 2-5 percent income tax that would be deductible from federal income taxes.

The measures, however, largely resembled previous Fox initiatives, and the convention's governor-led executive council never accepted the full proposal, pointedly rejecting the part that included VAT on food.

The council instead agreed to back the partial transfer of taxation powers from federal to state and local governments, along with a host of minor measures aimed at more efficient and transparent government spending.

Changes were also proposed that would gradually ease the tax burden on state oil monopoly Petroleos Mexicanos (Pemex), which contributes about one-third of total government revenue.

Fiscal bleeding has made the company heavily dependent on bond sales in recent years, and Pemex chief Raul Munoz Leos has warned that the company risks collapse if its tax load is not reduced.

However, the convention's proposals don't come without loose ends.

The proposed reduction in federal VAT would leave an estimated 40-55 billion peso hole in government coffers, and the convention recommended lawmakers revise the VAT exemption for food, though without suggesting a specific rate.

"We've done our part, now it's up to Congress," Chiapas state Gov. Pablo Salazar said at the convention's closing ceremonies.

Action there seems unlikely, however, as leaders from Fox's own party--which has been the only stalwart supporter of VAT on food--have said they will not propose or push for new debate on the issue in Congress.

Lawmakers of the opposition Institutional Revolutionary Party (PRI)--which holds a plurality in both houses of Congress--did not answer repeated interview requests over their position on VAT. The PRI split bitterly over VAT during last year's budget debate.

EYES ON 2006

Analysts say the governors--most of which come from the opposition--had the 2006 presidential elections on their minds when they rejected the tax hike.

Previous proposals for VAT on food and medicine sparked large-scale demonstrations, and both major opposition parties have campaigned against such measures, saying they are unfair to the poor.

"The political cost of raising taxes was too high for the governors--that's why the convention failed," said Jose Antonio Crespo, a political scientist at the Center for Economic Research and Teaching, a Mexico City think tank.

And even top lawmakers from Fox's own party said the impasse essentially kills the president's hopes of seeing genuine fiscal reform before his term ends in 2006.

"We probably won't be able to seriously take up fiscal reform again until we have a new president," said Gustavo Madero, a lawmaker for Fox's National Action Party (PAN) and head of the lower house Finance Committee.

Fox cannot run for re-election under Mexican law.

Madero added that "without tax reform, we're looking at very, very austere budgets for the coming years."

SILVER LINING

Regardless of the convention's failure to push for increased revenue, some still see its proposals as a healthy move away from Mexico's extremely centralized tax system.

The federal government last year collected about 92 percent of all tax revenues, and then distributed much of the money to the states.

"It's probably a good idea to have states collect and spend more tax money because local people know their problems better than federal bureaucrats on the other side of the country do," said Federico Estevez, a political scientist at Mexico City's ITAM university.

The convention also proposes allowing re-election for mayors--a first in Mexico since before the 1910-1917 revolution--and that municipalities be able to set their own rates for property taxes.

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Fox said the proposals to "federalize"--or decentralize--fiscal policy was a "first step" toward fiscal reform, and he urged federal and state legislatures to adopt the convention's accords.

The convention's accords also include proposals for states and municipalities to open up more to public scrutiny over how they spend tax revenue.

"The idea is that if states have more control over their finances, there should be measures to fight corruption," said Cesar Chavez, a lawmaker from the leftist opposition Party of the Democratic Revolution (PRD) who participated in the convention.

THE TAX EVASION WALL

Even before the tax convention's close, Finance Secretary Francisco Gil Diaz admitted that the 2006 elections make progress on economic reforms less likely, and officials have increasingly called attention to the government's efforts to boost revenues without new legislation.

Gil Diaz recently announced income tax collection had reached record levels at six percent of GDP, while VAT collection was up at 3.9 percent of GDP.

According to Jose Maria Zubiria, Mexico's chief tax collector, more efficient and aggressive auditing, coupled with a transition to Internet tax filing, have pushed up Mexico's total tax revenues over the past three years from 10.58 percent to just over 12 percent of GDP.

Tax evasion is rife in Mexico, where as much as half the workforce is off the tax books and the falsification of tax invoices is, in Gil Diaz's words, "a national pastime."

Zubiria said tax evasion drains government coffers of about 40 percent of potential VAT revenue, or around two percent of GDP, while income tax evasion probably costs the government about the same.

The government is planning a nationwide door-to-door survey next year to gather information for auditing and to get more people on the books.

But Zubiria says the government's efforts to stem tax evasion will likely run into a wall when revenues reach 13 percent of GDP, probably sometime in 2006. Since some evasion occurs even in the best-administered tax revenue services, "efficiency gains will be marginal after 13 percent."

This means bringing in enough revenue to improve services and reduce Pemex's fiscal burden is not likely to happen without a major legislative tax overhaul.

But Madero says "we might have to wait a few years for that."

Jason Lange is a freelance journalist based in Mexico City.