The future of VAT in Mexico
And when speaking of the state and its duties, the income required to fulfill the obligations demanded by the population, and the constitution itself, is overlooked. But the issue of government revenue is wildly distorted by mass media, by the population, and by the very politicians that act upon it. The media misrepresents it, polarizing between the good and the bad, denouncing corruption (inherent and despicable); the citizenry feels robbed (in many cases this feeling is justified); and the officials themselves, among their campaign promises, claim that they will bring abundance and that so many government programs will be implemented that the country’s major issues will disappear. Three stakeholders that tell their own truths – none of them is false, but they miss the greater picture.
But the issue of state revenue has been completely left out of the discussion, because the rejection to any form of tax is complete, and the reduction of government expenditure is applauded. Reducing the salary of high officials is as popular as the austerity of government offices. However, by dodging the subject – by failing to adequately deal with it – Mexico brings upon itself a serious tax revenue conundrum.
Not all taxes are collected equally, or have the same effect on the population. The first classification – and highly important when defining a country’s fiscal policy – is whether taxes are to be collected directly or indirectly. A direct tax means that it will be applied over the taxpayer’s income (whether an individual or a company), as the ISR correctly does, where those with a higher income will make a greater contribution to the government treasury. Indirect taxing has another effect, since it affects consumption, and therefore, its contribution will depend on the level of expenditure, which is what VAT and IEPS does.
México is the last country in the OECD in tax revenue; having high tax rates never had a high acceptance. Government expenditure was 22% of the GDP and less than 10% was collected – the difference was mostly covered by oil income, which has been declining due to the fall in the price of the barrel and the poor yield PEMEX has obtained during these last five years. So the recommendations of international organizations such as the OECD itself or the IMF are to prioritize a rise in indirect taxes such as VAT in order to prevent it from cooling off the economy; and not taxing income will not imply a blow to the corporate sector or inhibit present or future investments.
This may all sound good and well; however, there is another tax classification criterion that is to be weighed before choosing to increase any tax rate. And that is whether it is progressive or regressive. A tax is considered to be progressive when it mostly taxes those that have the most money, while it is regressive when it affects the lowest social classes.
If we consider a study by Centro de Estudios Espinoza Yglesias, 10% of the richest population contributes 40% of the tax revenue, while the poorest 10% contributes less than 2%. Based on this criteria, we could say that it is progressive. But this same study points out that 10% of the highest social class pays only 6.5% of its income in VAT, while 10% of the lowest social class destines 11.4%. Using this information, we can say that it is regressive, because the negative impact focuses mostly on impoverished people.
And we could say that other countries in Latin America have a higher VAT. Chile and Colombia have general rates of 19%, not to mention European countries such as Spain, with a rate of 21%. But these countries have a better public resource distribution than Mexico, confirming Mexico’s ranking of 121 over 137 in public expenditure efficiency, as per the World Economic Forum’s Competitiveness Ranking.
The issue of VAT and an increase may turn out to be beneficial for Mexico’s revenue structure – with the little that is invested in pernicious and social sectors such as education and security, it is paramount to have a greater resource availability. Raising VAT may be regressive, but accompanied by social assistance efforts focused on the lowest social class, its impact would be reduced. Unfortunately, Mexico’s government expenditure conditions are far from ideal, and in order for this recommendation to work, it should be accompanied by better mechanisms to oversee the allocation of public resources by the state.
By David Abraham Ruiz Ruiz
Bachelor of Finance, University of Sonora.