Mexico's Fiscal Overhaul Is Pain for Gain

The howl of condemnation heard in Mexico in response to the fiscal-reform proposal President Enrique Pena Nieto unveiled Sept. 8 is not surprising.

The howl of condemnation heard in Mexico in response to the fiscal-reform proposal President Enrique Pena Nieto unveiled Sept. 8 is not surprising: The plan angered political allies, irked the private sector, worriedbondholders and scaredthe middle class. Yet, though not perfect, the reform provides a needed overhaul of the Mexican economy.

The plan aims to raise government revenue by approximately 1.4 percentage points of gross domestic product next year, through taxing a host of goods and services and slashing exemptions. But it would also raise spending, by creating a new unemployment insurance system for instance, which added to the country's oil-investment budget would increase the government deficit to about 3.5 percent of GDP next year, the highest deficit level in 24 years according to Barclays Plc. Moreover, the proposal would raise debt issuance 35 percent above what was planned for this year, which may be a problem given that investors are already fleeing emerging-market debt as the U.S. Federal Reserve prepares to tighten monetary policy.

Not everyone is convinced. Reforma newspaper columnist Sergio Sarmiento joined a chorus of critics with his Sept. 10 piece, which claimed the government "has opted for a redistributive reform, a charitable reform, instead of a reform that increases productivity in Mexico."

Pena Nieto's initiative would raise the top income-tax rate by two percentage points to 32 percent and slap a 16 percent value added taxon various middle- to upper-class staples, such as private-school education, home purchases and rentals, jewelry sales, concerts, even pet products. A 10 percent capital-gains tax on stock-market investments would also apply.

Nacho Lozano, a journalist for Mexico's Uno TV, sent a Sept. 10 tweetthat voiced a common concern: "It will get a little pricey to be middle class in Mexico." A CNN Mexico article, "The 20 things you didn't know about Pena Nieto's fiscal reform," published on Sept. 8, has been tweeted more than 8,100 times and has more than 59,500 likes on Facebook. Topping the list: "VAT on food ... for your pets."

The reform's plan to impose a special tax on soft drinks such as Coca Cola would probably be a more equal-opportunity tax -- and a fitting one too. Mexico has the highest levels of adult obesity among industrialized countriesaccording to theFood and Agriculture Organizationof the United Nations, with 32.8 percent of adults being overweight, outpacing the U.S.'s 31.8 percent. This piece of the plan gained Pena Nieto an ally in New York City mayor Michael Bloomberg (founder and majority owner of Bloomberg News parent Bloomberg LP) who tweeted his kudos on Sept. 10: "Thanks to Mexican President Enrique Pena Nieto for taking action on the obesity epidemic & supporting a new tax on sugary drinks." Coca Cola, meanwhile, calledthe move "unjustified" and warned "a tax on a product cannot resolve a complex problem such as obesity."

A tax on Mexican Coke bottlers may be more in line with what Nobel-prize winning economist Joseph Stiglitz meant when he saidat a late August conference organized by Mexican brokerage Vector that the government should squeeze big business: "One of the unfortunate aspects of Mexico's economy is that it has many monopolies and oligopolies, so from a fiscal perspective there is a lot of money that can be collected there. The fiscal reform should focus on that type of tax."

Imposing a VAT tax on food and medicine would certainly have increased the tax base in Mexico, but, perhaps mindful of potential street protests, the president avoided this. It can be politically tricky to justify making everyday life more expensive for ordinary citizens in a country home to a telecom monopoly largely responsible for some of the highest phone rates among members of the Organisation for Economic Co-operation and Development, an oligopoly in broadcast television and no unemployment insurance system to speak of (though the reform would create one).

The fiscal plan is an overdue step in rearranging Mexico's priorities. Mexico's government has relied for years on dwindling oil production to cover about a third of its spending needs. In practical terms, this has meant squeezing state-owned oil company Petroleos Mexicanos, known as Pemex, so much that the company has seen production decline in recent years. Pena Nieto is already asking Mexicans to ease the state's 75-year grip over the energy industry enough to encourage much needed private-sector investment -- a big step for Mexican nationalists.

Still, Mexican politicians are not all fully on-board with the plan. Leftist leader Andres Manuel Lopez Obrador, known as AMLO, vowed to defeat this and other reforms by Pena Nieto's party, the Institutional Revolutionary Party, in a Sept. 9 tweet: "We managed to halt the VAT for food and medicine. Now we will stop the tax increase on the middle class and the energy reform will not pass." AMLO's own party, headed by Jesus Zambrano, was more supportive but had concerns as well over the VAT on school tuition and rentals. The National Action Party has also asked the president to eliminate the tax on private-school tuition, among other changes. El Universal newspaper columnist Alfonso Zarate addressed such detractors in his Sept. 12 column: "In fiscal matters it is impossible to satisfy everyone. By their nature, 'taxes' are just that, compulsory obligations that few people like."

A Sept. 9 editorial in El Universal perhaps put it best: "Any fiscal reform to improve tax collection would go astray if spending is poor or corrupt...It's the duty of Congress and the country's productive sectors to perfect (the reform)." If Mexico adopts the reform's broad outline, it would be a revolution of sorts for the country. That is something critics should keep in mind.

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