Developments of the system (from 1970 to 2000)

The current Mexican tax system barely resembles the structure prevailed forty years ago. Over the past four decades, developments of the tax system have been guided by the social and eco-nomic objectives pursued by the Mexican Government in different development stages. Before 1970, taxation in Mexico followed a highly pragmatic view. In response to the need to raise reve-nue with the least administrative burden, the tax system was integrated by numerous levies on industrial production, natural resources and international trade. Yet, as a result of important tax efforts to streamline administration and the introduction of a more efficient scheme to tax gross income, tax collection increased to 10 from 6.5 percent of GDP during the 1940-70 period. This substantial increase on the tax burden also responded to a gradual move towards an economy based on manufacture and service sectors, from traditional non-mineral primary activities.

In order to keep up with the economic strategy prevailed at that time towards industriali-zation and internal-market orientation, a set of tax reforms were approved by Federal Congress during 1955-1972. On the income taxation structure, a “cedular system” was replaced by general regimes for individuals and corporations based on “net global income”. For corporations, an ac-celerated depreciation scheme applicable to equipment was introduced as a mean to foster in-vestment in key industrial sectors. The new tax regime also featured special tax regimes for small taxpayers in primary sectors, such as agriculture, livestock and fishing activities, in such a way that fiscal authorities collected fixed amounts of tax, without regard of income, cost, and invest-ment performance. Also, these reforms included an overhaul of the indirect taxation structure. A number of production and sales tax were substituted by a simpler scheme based on a single turn-over tax. In the administrative sphere, a national taxpayers’ registry was created for the first time.

Between 1978 and 1981, another important set of tax reforms was introduced, basically aimed at adapting to a rampant inflationary environment. Previously, during the 1971-1975 pe-riod, public expenditure increased to 30 from 20.5 percent of GDP as a result of an significant expansion of state-owned enterprises. New findings of oil fields fed favorable expectations on oil revenues. As a result, the federal government decided to finance public expenditure with foreign credit resources and with inflationary taxation. In 1975 fiscal deficit reached 10 percent of GDP.

As a result of the second oil price shock and concomitant increases on oil revenues extracted form Petróleos Mexicanos, or PEMEX - the national oil monopoly -, President López-Portillo

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decided to further expand the number of state-owned enterprises under an ambitious program of public investment. Consequently, public expenditure reached 41.1 in of GDP by 1981, whereas inflation aroused to almost 30 percent. Income tax reforms carried out during this time addressed the inflationary adjustment as one of the main objectives. The tax schedule for personal income tax was corrected for the effects of inflation to prevent undesired distribution effects associated with “bracket-creeping”. Also, the capital gains assessment mechanism was revised to allow cost adjustment for general price increases. Though partial and incomplete, inflation adjustments paved the way for further reforms intended to fully recognize the effect of inflation on tax bases.

The indirect taxation structure was object of a deep reform. In 1980, a value added tax replaced the turnover tax, 30 federal excise taxes, and about 400 local taxes, under the policy objective of reducing typical distortions, such as the “cascading effect”, associated with a turnover tax system.

Starting in 1982, the administration of President De la Madrid faced a profound macro-economic crisis as oil prices collapsed, and external credit lines were depleted. In spite of the implementation of an aggressive economic adjustment through drastic reduction on public ex-penditures and the privatization of several state-owned enterprises, the Mexican economy fell into deep recession and inflation rates reached three-digit levels. As part of the economic pack-age, excises tax rates increased and the VAT was reformed to introduce a multi-rate structure. By the end of the 1980s, the tax system structure proved to be insufficient to address revenue, effi-ciency and equity concerns. At that time, the tax system contained a set of rules conceived for a different development strategy, such as uncompetitive tax rates, rampant tax credit allowances, and an uneven distribution of the tax burden among sectors. The new development strategy based on economic openness, deregulation, and privatization demanded a new tax structure compatible with the modernizing of the economic structure, to the adoption of the North American Free Trade Agreement (NAFTA) with the US and Canada, and to the entrance of Mexico in the OECD.

In due regard to these circumstances, the administration of President Salinas embarked on a profound overhaul of the tax system during the 1989-1991 period. In perspective, the tax legis-lative initiatives approved by Congress in this short period of time are reckoned to be the most substantial effort undertaken by the Mexican Government in modern times to streamline its tax system. As part of this set of reforms, income tax rates applicable to corporations were reduced to 35 from 45 percent, in an attempt to set a competitive level against trading partners: US (38.3 percent) and Canada (43.3 percent). To facilitate international trade and investment by reducing

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the capital cost of firms increasingly doing business in Mexico, officials form the Ministry of Finance started negotiations with partner countries aimed at reaching income tax treaties.

The maximum personal income tax rate was brought down to 35 from 50 percent. Full integration between corporations and individuals was allowed. In an attempt to foster compliance and increase tax revenues the Congress approved a new 2 percent asset tax, totally creditable against corporate income tax. The CIT structure was adjusted to fully incorporate the effects of inflation. PIT brackets were also adjusted for inflationary purposes. For small enterprises, a new simplified tax system based on cash flow was devised to comply with tax obligations with fewer accounting records burden. An important element of this reform endeavor was the overhaul of some deductions and exemption items included into the tax codes supported by weak economic rationale. Some tax incentives were trimmed, such as the accelerated depreciation scheme for investment projects carried out outside the areas of Mexico City, Guadalajara, and Monterrey. In others, deductions linked with executive meals and automobiles were curbed. Finally, special tax bases applicable to firms and individuals engaged in primary sector and other activities which usually conveyed a small or nil tax base for taxpayers, were eliminated. Finally, VAT rates pre-viously settled at 6.15, and 20 percent, were replaced by a single tax rate of 10 percent.

From a broad perspective, the tax reform effort carried out during the 1970 - 1990 period showed mixed results. The reduction of tax rates, the elimination of some unjustified preferential regimes, full integration of income tax between individuals and corporations, the total recognition of inflation effects into tax bases, and rationalization of the indirect taxation structure, provided a more efficient, fair, and competitive tax system. Nevertheless, those reforms fell short to provide the Mexican Government with an adequate source of non-oil tax revenues. By 1990, tax collec-tion as a percentage of GDP of 11.1 percent compared unevenly with other Latin-American countries such as Chile (18.6 percent), Brazil (17.6 percent), Argentina (14 percent), or Colombia (12.2 percent). The severe financial crisis underwent by the Mexican economy at the end of 1994 resulted in a substantial curtail of tax revenues. In fact, this reduction turned out to be even more severe than the contraction of national income. Tax-ratio decreased by 23 percent from 1994 to 1995. This effect was explained by the credit crunch experienced by economic agents, so that they financed short-term debt payments with tax withheld from income tax and VAT.

As part of the economic package put forth by the President Zedillo administration, VAT general rate increased to 15 from 10 percent along with a substantial increase of real prices of

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goods and services provided by public entities. At the same time, and in order to ease the effects of the financial crisis, the Government announced a set of temporal tax incentives, such as the reduction of the tax on assets general rate for small and medium enterprises, the immediate ex-pense of marginal investments carried out during 1996, and also tax credits to foster employment.

The emergent tax policy measures probed to be efficient to achieve the desired effects. The Mexican economy activity resumed relatively fast. By 1996, real GDP grew by 5.1 percent.

However tax collection increased by only 0.8 percent due to the effects of the corporate operating losses carried forward. The downward tendency was not reverted until 1997, when tax collection increased to 9.8 as a percentage of GDP, from 8.9 per cent in 1996. During the post-crisis period of 1997-2000, the tax reform agenda addressed again some issues pending after the 1989-1991 overhaul of the tax system. Clearly, its limited capacity to raise revenue scored high again in the Government priorities. In 1999, the tax-ratio reached only 11.3 percent of GDP, which turns out to be the same level of 1994 before the financial crisis. Yet, the plural composition of the Con-gress observed in 1997 for the first time in the modern history of Mexico, resulted in poor agree-ments to reach consensus upon a revenue enhancing reform. This lack of agreeagree-ments in Congress over one of the most pressing and unaccomplished issues in Mexico, still lingers as of today.

3. Some quantitative and institutional features of main taxes