Otto Granados Roldán
There is sufficient evidence to demonstrate that any competitive process of sustained economic growth is based on increases in productivity, the levels of investment made by a country, and the institutional and regulatory framework. The first depends on education, talent development, innovation, and technology. The second depends on the country’s offers of investment opportunities and the availability of public and private resources. The third relies on the rule of law and an efficient regulatory framework.
But both more or less serious politicians and academics, as well as occasional analysts, who proliferate like mushrooms in today’s Mexico and have no idea how markets and public bureaucracies work at all levels, simplify this process trying to find the Holy Grail and reduce it to a tax reform which, so far, no one knows what it might consist of but sounds chic. Whatever it is, they argue that everything is solved by charging more taxes to whoever they can, especially, of course, to taxpayers who are in the formal economy.
But they graciously omit the other half of the equation: the quality of public spending in Mexico and, in fact, in all Latin American countries is deplorable. Therefore, collecting more money without rigorous planning, targeting, monitoring, and evaluation of what is done with it is to hand it over to the execution of a devouring, corrupt, and insatiable bureaucracy.
The literature on the subject is robust and abundant. In Latin America, the everlasting misallocation of public spending -which increased by an annual average of 7 percentage points in the last two decades- not only seriously damaged the macroeconomic sustainability needed to face recessionary cycles but also reduced inequality by only 4.7 percent. In contrast, a combination of efficient policies and functional institutions -the so-called “smart spending”- reduced it by 38 percent in advanced economies. Smart spending refers to the strategic allocation of resources to areas that can yield the highest returns in terms of growth, equality, and productivity.
As identified by an IDB study(https://flagships.iadb.org/es/DIA2018/Mejor-Gasto-para-Mejores-Vidas), the region has some of the most inefficient examples of public spending in the world (which in 2016 represented 29.7 percent of GDP), due among other things to public sector incompetence, waste, corruption, misallocation, lousy governance, or a mix of all of these. This explains that such public spending – that is, that which did not serve to improve growth, equality, or productivity – was equivalent to 4.4 percent of GDP (about $220 billion), of which four-fifths was misallocated or misexecuted in public procurement alone and in waste, losses, exemptions, waivers, write-offs or “leakages” in energy subsidies, social programs and the tax framework itself. In fact, some of these subsidies went to the higher-income population, with the top decile receiving a quarter of all benefits and the bottom decile receiving only 5%, meaning that the rich received five times more subsidies than the poor.
In Mexico alone, a quick review illustrates that much of the inefficiency of the tax framework is explained because it is poorly designed and riddled with holes under the labels of exemptions, exceptions, fiscal stimuli, subsidies, and what the Ministry of Finance euphemistically calls “collection waivers” (https://www.gob.mx/shcp/documentos/renuncias-recaudatorias-2024), by virtue of which the Mexican treasury will fail to collect almost 533 billion pesos in 2024 due to reduced VAT rates, while in 2025 it will amount to more than 567 billion pesos.
The second largest “waiver” is the so-called “stimulus,” for which the Treasury will not collect close to 339 billion pesos this year and will waive 333 billion pesos for the following year. And the third waiver derives from income tax exemptions for individuals (265,615 billion pesos this year), followed by VAT exemptions (85,464 billion pesos) and income tax deductions for individuals (45,232 billion pesos).
See the case of VAT, where a series of activities, goods or services are exempt or zero-rated: jewelry, gold, goldsmithing, ornamental and artistic pieces; processed pet food; chewing gum; tractors of all kinds; caviar, smoked salmon and elvers; herbicides for agriculture or livestock, and a long and surrealistic etcetera(https://www.sat.gob.mx/articulo/06071/articulo-2-a). In 2024 alone, the amount of the waivers collected by the zero rate of this tax will be equivalent to 1.56% of the GDP. Or because there are privileged companies that enjoy discretionary treatment, such as Pemex, a company that the federal government announced in February of this year that it would forgive the payment of taxes for some 87 billion pesos because, in addition to its proverbial inefficiency and corruption, it is technically bankrupt.
Not to mention the case of Mexican states and municipalities that have found the most honest solution: to look good to the gallery and not get into mazes of exceptions/exemptions, they collect almost nothing. Let’s look at two examples. One is the registration fee, or what is now called, with a particular euphemism, vehicle control rights. It turns out this was born in 1962 as a federal tax, but over the years, it became a local tax whose revenues were a good source of funds for the states. It was a tax with several advantages. One is that it is a progressive tax and not regressive; that is to say, those with high-end or luxury vehicles pay more, and those with a modest car pay less. Another is that it is an environmental control tax, one of those now called green taxes, whose purpose is to discourage the use of private vehicles to make mobility more efficient, reduce polluting emissions, and improve travel times. And one more, which is easy to collect.
Over the years, however, and for electoral reasons, it was practically suspended, or a meager fixed amount was established for all units, which meant that the states lost an essential source of their income. In 2008, the last year in which it was federal, 35 billion pesos were collected at the national level; in 2020, when the states already managed it, it fell to 15 billion pesos, that is, 55% less than twelve years earlier, and six states did not even collect it. On the other hand, the vehicle fleet increased by 155 percent, so if the registration tax had been maintained at the appropriate rates, the state collection would have been relevant.
The other gap is the property tax, a source of income that in Mexican municipalities represents only 0.13% of GDP while in other countries it represents between 2.5 and 3%. As mayors do not want to pay the political cost of collecting taxes and have become addicted to federal fiscal participations, which are 73% of their total revenues, property tax accounts for a modest 8.8% of what is received by the local treasury(https://revistavivienda.infonavit.org.mx/2022/06/24/el-predial-en-mexico-por-que-se-recauda-tan-poco/ ). This is partly the cause of the urban development disaster and the poor quality of public services in many of the country’s cities.
Therefore, the design, formulation, and implementation of public policies that impact growth and equity must begin to address, or rather, overcome these inefficiencies, increase the tax base, reduce informality, and combat evasion, if a virtuous circle that improves the lives of most people in a sustained manner is to be articulated. The moral is clear: we must mend the broken sack before filling it again with policies that have already failed in the past. The great economist Deirdre McCloskey says it well: the solution to the growing concentration of wealth is not to be found in a government that sets confiscatory taxes on the rich to give to the poor – after paying a heavy corrupt bureaucracy – but in lowering them to everyone.
It is in this context that any tax change in countries with high institutional and legal weaknesses and with inefficient and opaque governments such as the ones we suffer in Mexico, both at federal and sub-national levels, must be examined, starting from a common sense principle: no tax reform is an end in itself but a means to increase public investment capacity, and it will only be successful if it promotes economic growth at significant and sustained rates. Let’s take it one step at a time.
The need for fiscal reform in Mexico is an old issue. Among the abundant specialized literature, the recommendations that the World Bank (WB) prepared for Mexico since 2001 (https://documents1.worldbank.org/curated/zh/300371468774563671/pdf/29801000182131491417.pdf) stand out, for example, in which it insisted that Mexico’s fiscal anchor, with a tax collection then equivalent to 10% of GDP (today it is at 17%), was “unsustainable and will probably compromise the macroeconomic framework in the medium term and maintain the recent trend of public underinvestment”.
At that time, the WB pointed out the urgency for Mexico to “comprehensively reform its tax system” based on five criteria (collection effect, economic efficiency, social equity, administrative simplicity and political feasibility) and to include modifications in the already known areas (VAT, income tax, exemptions and special regimes, among others) to achieve, as a whole, an immediate effect of 3% of additional public revenues as a proportion of GDP and, four years later, between 5 and 6%. Well, part of the explanation lies in the hypothesis that the Mexican economy grows at very low rates due to a very weak gross fixed capital formation, that is, the percentage of investment, compared to several countries. In other words, if there is no more money, you cannot invest more; if you do not invest more, you do not grow at a higher rate. So far, it sounds logical. But since in Mexico, things tend to happen precisely the opposite way than in the rest of the world, investment does not always drive the economy here.
For example, the Huatusco Consensus – the reflections of a very serious group of Mexican economists (there once were) who used to meet in the past – found that in recent decades, the investment ratio has remained relatively constant, but its contribution to growth has declined markedly. Between 1960 and 1979, investment was nearly 20% of GDP, and growth averaged 6.5%. Between 1980 and 2002, investment remained at similar levels, but average growth was less than 3%. And the current percentage of investment is 24.9% of GDP, and growth during Morena’s six-year term will end up being 0.8% annual average. What happened?
Although the causes may be varied, those from Huatusco rightly concluded that a good part of that financing went to poorly conceived and planned projects with zero profitability (such as the Santa Lucia airport, the Mayan Train, or the Dos Bocas refinery) and reflects that “to increase the growth rate, one cannot only contemplate an increase in investment as an instrument but its contribution to the overall factor productivity in Mexico”. This is a crucial aspect of any reform: there is indeed a positive correlation between having more public revenues and achieving growth objectives, and this does not depend only on collecting more but also on investing much better where productivity and the formal economy have the most significant impact.
In other words, if there is no radical change and transparency in the structure of public spending and how it is exercised, any fiscal modification will fail in terms of its essential purpose. This is the great paradox: for it to pass politically, it is enough to be approved in the Legislature. For it to be an economic success, it needs a profound reform in spending that will bring order to those who exercise it -the federation, states, and municipalities- improve its quality, make public investment productive, and stimulate the growth of the country and the states. There is no other way.
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