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Mexico: Economic Development and Tax Reform
By Carolina Bolivar In a short time, Carlos Salinas de Gortari has
managed to win the trust of a great number of Mexicans, and
especially of businessmen, who at the start of his presidency would
have wished for a change of political party. In spite of the
disillusions and previous bad experiences with the ruling
Institutional Revolutionary Party (PRI), the business and labor
sectors have shown themselves to be generous and ready to deal with
Salinas and support h im in the efforts needed to defeat the
economic crisis. This is because Salinas de Gortari has known how
to handle public opinion and has taken intelligent measures which
seek to free the Mexican economy and sponsor development. Among the
important change s that Salinas de Gortari has made to regain
credibility: * He has fought inflationary pressure, lowering the
price index from 159.2 percent annually in 1987 to 19.7 percent in
1989. In part this was possible because the issuance of currency
dropped from 1 4 0 percent annually in 1987 to 40 percent in 1989.
It is important to point out that this reduction is also due to
agreements to freeze prices and wages. I * He reduced the
percentage of government deficit in relation to Gross National
Product (GNP) from - 113 percent in 1988 to 6.3 percent in 1989;
however this was achieved not by the reduction of spending, but by
increasing tax revenue.yCurrently, 72.2 percent of government
revenue comes from taxes, which have become the principal source of
funding? * Ano t her achievement was that, according to officials,
the government had the highest budget surplus in the country's
history: 8.3 percent of the GNP. 4 This surplus is presented to
public opinion as proof that the Salinas de Gortari administration
is efficien t and is eliminating losses. * Ile privatization of
1,155 businesses, begun by former President Miguel de la Madrid,
has continued under Salinas de Gortari, and it is currently
estimated (there is no certainty because published reports do not
always agree) that there are still 389 businesses run by the
government. The official goal is that at the end of Salinas de
Gortari's administration there be only 100.
Carolina Bolivar, a former Visiting Fellow with The Heritage
Foundation's Mexico Project, is president of the Ludwig von Mises
Institute, a Mexico City research organization dedicated to free
market economic development in Mexico. She spoke at a meeting of
The Heritage Foundation Mexico Working Group on July 19, 1990. ISSN
0272-1155. 01990 byThe Heritage Foundation.
1 Banco de Mdxico Annual Report, 1989. 2 La economia mexicana al
primer semestre del afio, 1990; Centro de Estudios Econ6micos del
Sector Privado (CEESP). 3 Banco de M&ldco Annual Report, 1989.
4 Banco de Mdxico Annual Report, 1989.
* Meidc o-U.S. relations have improved considerably and this has
increased the trust of the private sector, and the middle class in
general, in the government. * His intention to reach a Free Trade
Agreement with the United States and Canada has also been very po s
itive for Salinas de Gortari's image. The tax policies, which have
become the most controversial topic in Mexico today, contrast with
this atmosphere of optimism and openness. Some of the tax reforms,
and especially certain aggressive attitudes of the aut horities, do
not agree with Salinas de Gortari's plan for modernization. They
are contrary to the objectives of commercial openness and the
privatization of state-run enterprises, which seek to strengthen
industry and commerce.
BUSINESS EXPECTATIONS
The government has permanently modified the tax system since
1986; its objective has been and is to combat the decrease of tax
revenue which began a decade ago. This decrease was due, in part,
to the lack of credibility by Mexicans in the populist government s
of those years, and the high income tax rates which they imposed
and which reached 60 percent. De la Madrid, aware of this, reduced
the rates to 40 percent before the end of his term. Due to the
great differences between the economic policies of Salinas d e
Gortari - who favors a free market - and previous presidents - who
favored central planning - businessmen and employees expected major
decreases in the tax load. Of course, significant changes took
place, but these were somewhat different from what was e xpected.
The tax reforms traditionally approved by Congress in November are
known as "tax miscellany." In spite of the fact that the general
objectives of the "tax miscellanies" of 1989 and 1990 have a free
mar'ket orientation, some of their laws and stra tegies contradict
Salinas de Gortari's determination to open and free the Mexican
economy.
TAX REFORM
Objectives According to Pedro Aspe, Secretary of Finance and Public
Credit, the objectives of the tax policy are: 1) to stimulate
economic growth, 2) to increase the standard of living, 3) to
equalize interest rates with foreign rates for product prices to be
competitive and favor exportation, 4) to widen the tax base, and 5)
to obtain more funds to finance and reduce public spending.
Tariffs, Means and S trategies The tax authorities announced that
their program would contain tariff reductions and some support
measures. The maximum income tax rate was reduced from 40 percent
to 35 percent and the marginal rates of other taxpayers were also
adjusted. These measures generated political support for Salinas de
Gortari. Mexicans felt encouraged by this announcement, since
govermnent concessions to the people are rare. At the same time,
2
however, the tax brackets were changed significantly; with the goal
of compensating for the tax rate reduction and inflation, "minor"
taxpayers (those with low salaries) had their brackets changed and
they were classified automatically as "major" taxpayer s (those
with high salaries). The following chart shows these modifications.
ANNUAL INCOME TAX RATES (Converted to U.S. dollars @ 2,600 pesos)
.. .......... ....... .... .. ....... .... -::-Inc0-M'e--f neome
........ . 1989 r", 1990 . . . . . ....... ..... ... ...... .. . ..
. ...... ... ... ...... . .. ......... .......... .. rac a Mat-Anal
Rate I Ra '-"k . ......... ........ M 11,.Wna te ....... .........
... .... .... .. . ..... ... ................ ... ............. - ,
"": ..... ...... .... .. ....... . .... @3 ..: . . ...... -:' :,
12-:: ....................... 3% 3% ........... ..... .........
..................... .. ........ ........ ........
....................................... ............... :.rr . . .
... .... ..... ... ............ 2:'- 10% . . .. 10% . . .... ...
......... ... ........... .......... 4 .:%%%%%%%2-'02 "A" 18% 17% .
.......... ............... `999 -1- 28% 25% ..........
...................... ... ............. 5 11 6 ...... :9 32% 38%
9.. ... .......... ..... .... .... ......... . . ..... ............
. ... ........... .................................................
............. ................ .... ........ 40% 35%
This new classification has caused strong irritation among
businessmen. Minor taxpayers have seen their income af fected by
the change in their bracket. For some of them it was already
difficult to face thebigh cost of living; frozen salaries and these
modifications have made it almost impossible. The change has also
caused the bankruptcy of many small businesses, wh o se profit
margin did not permit them to defray operating expenses, nor pay
the increase in taxes. Ile reduction of marginal rates is more
evident for the people than the changes in tax brackets, and
therefore generates public support. The economic reality , however,
belies this perception. Says economist Alan Reynolds, "Curiously,
the salaried Mexican reaches the highest marginal rate with an
annual income of only $6,957. In the United States, a taxpayer with
that same income, and under the same circumstanc e s, would pay no
tax. Of course, an equivalent amoNnt of dollars buys more in
Mexico. But even so, the maximum category is extremely low.' Other
groups which before paid no taxes were converted to minor
taxpayers, for example: artists, independent workers o f modest
means, peasants, small market merchants and street vendors, among
others. These last three groups could not be integrated in the
intended way, because the reforms were not well thought out. Now
all will pay the same fixed rate. As far as other ta x es are
concerned, some suffered significant increases, as in the case of
real estate taxes, which in Mexico City increased between 80 and
3,000 percent in some instances. Others did not change, such as the
value added tax (VAT) of 15 percent, the business payroll tax of 2
percent, the education tax of 2 percent as well as the I percent
federal tax on personal income.
5 Midco 2000 (Polyconomias Inc., New Jersey, 1990), p. 1M.
3
NEW TAXES
A new tax on business assets of 2 percent was implemented in
1989 to compensate for the decrease of income tax collection and to
increase government revenue. This tax did not generate much revenue
in 1989, but has given excellent results in 1990, bringing in the
equivalent of 12.7 percent of the income tax collection be t ween
January and March.6 The three taxes which generate the most revenue
in Mexico are the income tax, the value added tax, and the tax on
fixed assets. Together, they r? resent 72.2 percent of the taxes
collected and 51 percent of total government revenu e . Other taxes
have been hidden in the bills for services. The government has
renamed some sources of revenue so they would not appear to be
taxes. Ile telephone tariff is a good example: the old tax is now
called "rent" and the new tax is called "special tax for production
and service," in addition to the 15 percent VAT. Similar changes
have been made in the bills for electricity, water, gasoline, and
highway tolls.
ADMINISTRATIVE SIMPLIFICATION
Many modifications have been made to the laws as well as to the
procedures for the payment of taxes in order to facilitate their
application. "Ile simplification of transactions and the increase
in the number of taxpayers are essential for the success of the tax
miscellany. We should simplify the procedures for th e people to be
able to pay," said 8 Finance Secretary Aspe when the reforms were
being introduced. Almost at the same time, Mariano Azuela,
Magistrate of the Supreme Court, declared publicly, "When I learned
of the new tax measures I felt like a mental ret a rd, because I
didn't understand them; but when I knew that not even the
accountants understood them, I felt better.119 The government
requires that all commercial transactions be paid with a check from
the business' account, that a record be kept of incom e and
payments, and that photocopies be kept of all receipts and checks
given or received.1be people who planned the procedures and methods
of payment apparently took into account neither the different
social means nor the respective cultures of the people at whom they
were directed. Nor did they think of the structure of the agency
needed to implement these policies. A large percentage of the
taxpayers of this type, which are about 1,400,000 small businesses,
do not have a checking account, do not know how to keep accounting
books, and cannot afford to hire accountants. The instructions for
registration and procedures for payment are difficult to
understand. The government personnel in charge of collections are
as confused as the general public. The laws an d regulations are so
ambiguous and complex that even if the best advisors do the
accounting and even if all stipulated taxes are paid, there is
still the risk of breaking the law because certain precepts can be
interpreted in different ways. These problems have led
6 Report on the Evolution of the Economy and Public Debt in the
First Quarter of 1990. Mexican Department of Finance and Public
Credit. 7 ]bid. 8 E=elsior, April 30, 1990. 9 Ewelsiar, April Z7,
1990.
4
to many protests and marches' throughout the country against the
reforms. Even the more important accounting firms have shown their
displeasure with the reforms.
"TAX TERRORISM"
At the same time, the Department of Finance has tried to end all
tax evasion, using measures such as investigations, audits, fines
and even prison terms to penalize evaders. These are some of the
reforms made to the National Tax Code, which are in effect s ince
January 1, 1990: * Article 111 states that those who falsify losses
in their business with the intent to evade tax payment will be
sentenced to between three months and three years in jail. *
Article 115-bis states that if a taxpayer trying to avoid p ayment
of taxes engages in illicit activity or disguises the origin of
goods by transporting them from one part of the country to another,
or to another country, he or she will be condemned to between three
and nine years in prison. - Forty-nine businessm e n of various
levels were convicted and sentenced for tax evasion in 1989 to show
that the government was serious in its intent to apply the law.
Currently, many businessmen are fearful. Some have already been
tried for tax evasion and others are under inv e stigation. The
combination of complexity of the law and penalties have brought
about corruption at certain levels. Many businessmen are confused
and frightened because they must declare and pay taxes, but do not
know how to go about it. The aggressiveness of the government in
enforcing the new laws has caused many protests and lockouts
throughout the country. The response of Finance Secretary Aspe to
this was, "Although it displeases some, we will increase
investigations. We plan to investigate 10 percent of the
taxpayers." This attitude is disconcerting. The so-called "tax
terrorism" would seem to come from an opposition group, and not
from a government which seeks to regain credibility and support
from the business sector.
EFFECTS AND IMPLICATIONS OF THE TAX REFORMS
Immediate results The short term objective of the government of
increasing tax collections has been achieved. Between January and
March of 1990, budgetary revenue for the federal government was 28
billion pesos; that is to say, a real level 4 .5 ercent higher than
for the same period in 1989 and 13.8 percent over what was
expected. Flo Tax collection is much improved compared with
previous years. However, these measures could have serious
implications in the medium and long term. It is difficu lt to
estimate the economic, political and social impact which these high
taxes and penal measures produce.
1 0 Report on the Evolution of the Economy and Public Debt in the
Fust Quarter of 1990. Mea-dcan Department of Finance and Public
Credit.
5
Economi c Impact What has been the cost in investment and formation
of capital? How many business which would have been started were
not started? How many jobs which would have been created were not
created? It is estimated that in the last nine years, the format i
on of capital in Mexico has dropped 14.2 percent." The efficient
use of resources generated by society constitutes the difference
between a rich country and a poor one. In Mexico, as in many
developing nations, taxes drain the economy. Much capital which c
ould have been productive is used to finance the current spending
of the public sector, which is not productive. This has meant fewer
businesses and jobs. How much has the modernization of businesses
been impeded by taxation of fixed assets? How much inve s tment in
new machinery, in technology, and in new equipment was lost because
of these measures? It is well known that the more something is
taxed, the less of it there is. It is strange that a government
seeking economic expansion and greater tax revenues would apply
these types of taxes. "Just as excise taxes on liquor and tobacco
are designed to discourage the use of those products, taxes on
earning additional personal or business income must likewise
discourage the process of wealth creation that leads t o increased
income. How much revenue was lost from businesses which went
bankrupt, or passed from the formal to the informal sector in order
to avoid problems and red tape? The heavy tax loads, which
represent a large disbursement of money, makes people t h ink of
how to evade them, and it makes the government think of how to stop
these people from being productive. More and more laws and
regulations are created, which complicates the process further and
unleashes a vicious cycle difficult to break. When the s e factors
converge, and investigations are carried to an extreme, the risks
of being investigated are greater than those of living in the
anonymity of the black market. If tax policy does not change in
Mexico, the black market informal sector of the econo m y will
grow. It is difficult to estimate how much investment of Mexican
and foreign capital in Mexico was discouraged by these policies.
According to statements from the National Chamber of Industrial
Transformation, the government expected $16.5 billion o f foreign
investment during the first quarter of 1990, but only $9.8 billion
were invested. It is hard to say if this was due to the tax policy,
but it could very well have been. Ile tax reforms must co-exist
with the Pact for Stability and Economic Growt h (known as PECE for
its Spanish initials), which will keep prices and wages frozen
until January of 1991. In the coming months, most businesses will
not be able to change their prices, and salaried workers will not
be able to increase their income. Howeve r , both will face a la iF
er tax load than in the previous years and an inflation estimated
to be 25 percent in 1990. The co-existence of these forces, which
appear to be opposed, will be a difficult obstacle to achieving
growth in the Mexican economy. Ile results will undoubtedly have
important effects for Mexico and the PRI in the 1991 federal,
state, and municipal elections.
11 Statistics from the World Bank. 12 Mddco 20M, op. cit, p.
160. 13 Centro de Estudios Econ6micos del Sector Privado
(CEESP).
6
Political Impact The middle and lower classes, which have not
only made enormous sacrifices in the past fifteen years because of
the economic crisis, but also have a continually dropping standard
of living, are very resentful of these government measures, because
they make them poorer each day. Many of the tax reforms, the cost
of services, inflation, and the continuous devaluation of currency
are hurting their economic welfare and decreasing their chances for
a better life. To this must be added the corru p tion of a large
number of public officials who continually harass them and take
through bribes what little they have left. This form of corruption
is reaching alarming proportions. The harassment of small
businesses with excessive. taxes and too many laws and regulations
are causing them to go bankrupt. Ibis could have disastrous results
for the Mexican economy since these small companies account for 65
ercent of total employment in the country and constitute 95 percent
of the industrial base.P44 Even when certain tax measures have been
revoked for not being feasible, the "tax miscellany" has been a low
blow to the trust of the citizens, who had begun to believe in the
possibility of economic improvements and in the good intentions of
Salinas de Gortari. Th e members of the so-called "Cardenista
Party" (now the Party of the Democratic Revolution or PRD) have
used many of the errors in the tax reforms as a banner behind which
to rally peasanis and workers against the government. This
represents a high politica l cost for the government. The Mexican
people have been hypersensitive because of the haughtiness,
arrogance, and deceptions of previous governments. The current
authorities must be careful, as their actions could unleash a
credibility crisis which would o ffset the gains made by Salinas de
Gortari.
Social Impact These policies of high taxation also have an
important impact on Mexican society. Many young specialists,
important for economic development, leave the Mexican market
because salaries, besides being lower than in other countries, are
even further reduced by high taxes. "The maximum rate of 35 percent
is high relative to the present American top rate of 28 percent
..... The holder of a graduate degree in computer sciences, for
example, will typically earn $15,000 per year in an entry-level
position for which he will pay $6,000 in income taxes. The same
graduate can earn about $50,000 in a similar position in San Diego,
9915 and pay $14,000 in U.S. Federal Taxes. Mexico, along with many
other developin g nations, loses much human capital each year. The
best men and women in the country, including peasants, leave in
search of better opportunities and more attractive markets.
ORIGIN OF BAD POLICIES
Are bad policies the result of bad faith by government le aders?
Ludwig von Mises, knowledgeable about the defects and causes of the
economic backwardness of nations, attributes them to the negative
influence of professors at the universities where many of these
future leaders of developing nations studied. "To make their own
people as
14 El empleo y los salarios en 1989 (Instituto Nacional de
Estaftfica, Geografta e informitica, M&dco, 1990). 15 MAdco
2000, op. cit., p. M
7
prosperous as those of the West became their foremost aim. So they
sent the elite of their youth to the universities of Europe and
America to study economics and thus to learn the secret of raising
the standard of living. This is what these professors - M a rxians,
Fabians, Veblenians, socialists of the chair, champions of
government omnipotence and all-round planning, peacemakers of
inflation, deficit spending and confiscatory taxation - taught
their students ... the formulas of pseudo-progressism. They hav e
even today not yet realized that progressive taxation has already
exhausted this alleged surplus in all other countries and will have
exhausted it even in the United States very soon."16 Universities
such as Harvard, MIT, and The London School of Economi c s have had
a negative influence on the underdeveloped nations. The errors are
not of bad faith, they come from false ideas mixed with academic
arrogance, which have damaged these economies. If we add to this
the influence of counselors with bureaucratic m e ntalities and
little faith in the efficiency of the free market, such as
officials from the International Monetary Fund, we will better
understand the reason for this backwardness. "We must comprehend
that it is impossible to improve the economic conditio n s of the
underdeveloped nations by grants in aid...It is a spiritual and
intellectual problem. Prosperity is not only a matter of capital
investment. It is an ideological issue. What the underdevelo .Red
countries need first is the ideology of economic fr eedom and
private enterprise.""'
CONCLUSION
President Salinas de Gortari faces many challenges. The decade of
the 1990s is an extraordinary opportunity to integrate, through
free trade, the markets of the United States,' Canada, and Mexico.
This is a hist orical moment of great consequence in which there
exists the possibility of turning political violence into economic
splendor. Mexico will be a mirror which reflects the ability of
Latin America to form an economic bloc for the benefit of the
entire conti n ent. For this to occur, Salinas de Gortari must
continue with the freeing of the economy and convert Mexico into an
economic power. The country has enormous natural resources and
sufficient human resources to make this possible. The important
thing is for his government to be realistic and favor the dynamics
of the free market and not obstruct it with excessive regulations.
The measures he has adopted are correct in principle, but do not go
far enough. There is still the need for a major effort to lay thei
r foundations, without which the results could be precarious. It
will be necessary to change the tax policy of his government, since
this presents serious deficiencies and does not agree with the
objectives of modernizing the country. Tax Policy For Develo p ment
Here are some proposals for a tax policy which does not obstruct
economic growth. The punitive and anti-business approach, which
discourages investment and compliance with tax obligations, should
be transformed into a positive tax policy of low rates which
stimulate and attract investment. This will generate a climate of
trust which will be reflected in economic growth.
16 Money Method and the Market Process, Essays by LudWg von Mues
(Praxeology Press of the Ludwig von Mises Institute), p. 171. 17
Ibid., pp. 172-173.
8
* Free fixed assets from all taxation to stimulate capital
reinvestment, which is necessary to modernize businesses and allow
them to acquire new production equipment. * No taxes on the
purchase of equipment, machinery, and new techn ology to improve
the quality and productivity of the Mexican economy. * No taxes on
savings and capital which is brought back to the country for
investment. The restructuring of the economy requires much capital.
* Low and attractive income tax rates, not greater than 10 or 15
percent uniformly and without any exceptions. 11is will encourage
the formation of capital, and stimulate people to pay their taxes
and would teach them to live within the law, thereby widening the
tax base. * Put into effect promoti o nai discounts for advanced
payments, as has been done for years with the real estate tax. *
Allow education deductions from taxes. The creation of training
programs for workers in all cases and conditions where necessary.
Education and training are indisp e nsable for increasing quality.
* Drop the VAT to 5 percent, and phase it out, as is being done in
the case of local businesses which work with "maquila" companies
for export. * Mexican taxes should be lower than those in the
developed nations for its pric e s to be competitive. Mexican
tariffs continue to be higher than U.S. and Canadian tariffs, which
hurt Mexican products in the integrated markets under free trade
agreements. Other parallel and important economic policies are to:
* Balance public spending t o avoid a deficit which causes an
increase in tax rates. * Free prices and salaries, since the pacts
under which they were frozen are deceptive palliatives that sooner
or later generate counter-productive effects. * Restore to the
Constitution measures wh i ch guarantee private property. * Free
the financial market, which is currently designed to finance the
government through the sale of official bonds. The Mexican stock
market should become interriational. It must become a true market
tool to finance inves t ment and facilitate the transfer of
capital. * Achieve privatization through the stock market. IMe
break up of stocks would give the public the opportunity to have
access to the property of businesses. T'his, in addition to
increasing government revenue, w ould increase its popularity and
would defuse criticism and opposition from socialist leaders. *
Optimize the services obtained through the payment of taxes, so
that the citizen will understand the benefits of paying his share.
* Simplify as much as possi b le red tape, which is now excessively
complicated, to decrease the cost in time and money. * Decrease the
number of public employees who currently cause an increased
economic load. The government should strive toward efficiency and
productivity by doing m ore with less people.
9
* Accountability in the handling of resources should be adopted
by the government to rescue its moral authority. * Improve the
Mexican infrastructure, which is still precarious. It is necessary
to build more highways, expand and m odernize ports, and optimize
means of transport and communication. All of these elements
together will favor productivity and encourage economic growth.
They will stimulate the taxpayer to meet his tax obligations and
will increase government revenue with out the need to hurt or
irritate society with high taxes and punitive measures.
1 0
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