Mexico: Congress Faces a Taxing Time

Fiscal reform has been a top priority of President Vicente Fox since he took office a year ago. Although Congress is actively debating the issue, any real progress is unlikely this year, and inaction could be costly.

The economy has been in a recession since the first quarter, and the September 11 terrorist attacks on the U.S. will extend the slump into next year, sapping revenues, especially from the country's two key sources: oil exports and tourism. Both foreign and local investors are bound to get increasingly nervous over the slow pace of the reform efforts, which could delay Mexico's long-awaited investment-grade credit rating from Standard & Poor's.

So far, the peso and the bolsa remain surprisingly strong, but Congress is expected to pass only a watered-down version of fiscal reform by yearend, which may pack less of a punch than S&P and investors would like to see. The problem is not simply raising more revenue to pay for health, education, infrastructure, and past debts. The litmus test for fiscal reform's success, says economist Gray Newman at Morgan Stanley Dean Witter & Co., will be improved efficiency of tax collection and enforcement.

Mexico's tax base is exceptionally narrow. Taxes are only 11% of gross domestic product, compared with 30% in the U.S. and 18% in Chile. Taxpayers hide behind a long list of tax-free goods and loopholes, including special tax treatment for some.

Extended weakness in Mexico's economy only heightens the urgency for fiscal action. Exports are already suffering from the new U.S. weakness, although imports are also falling due to rising unemployment and weakening domestic demand. That's keeping the trade deficit stable, but the declining price of oil is biting into government revenues, a third of which come from oil exports.

After growing 6.9% in 2000, the economy ground to a halt in the second quarter. Economists expect zero growth this year, with no meaningful recovery before the second half of 2002.

By James C. Cooper & Kathleen Madigan

With Geri Smith in Mexico City

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