During the last 25 years, the Mexican tax system has been subject to a permanent reform process geared towards providing a more competitive fiscal environment to economic agents. As a result, the tax legislation includes some salient efficiency features, such as full integration of dividends, recognition of inflationary impacts, and relatively competitive statutory tax rates. Facing the need to adapt to an increasingly open and modern economy, the tax system has successfully adopted international best practices, such as standard transfer pricing guidelines. Also, the Mexican tax system has adopted a wide network of tax treaties to avoid double taxation and exchange of in- formation, with more than 30 partner countries. The membership of Mexico to the OECD and NAFTA has greatly contributed to the tax system modernization process. Nevertheless, the pur- sue to a more competitive and efficient tax system has not get through along with parallel reforms to strength its revenue capacity. The tax system is currently limited by its own structure to yield
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adequate collection levels. Therefore, the key issue on the reform agenda is to bridge the gap between actual and potential tax capacities, primarily by broadening tax bases while keeping tax rates to competitive levels. By doing so, it is expected not only to attain revenue targets, but also to alleviate horizontal inequities currently originated by unjustified preferential treatments, as well as to ease compliance and the administrative costs.
Several efforts have been attempted in the recent past to overcome some of the revenue insufficiencies embedded into the tax code. The Executive Branch of the Mexican Government has recurrently sent to Congress diverse reform initiatives with the explicit objective of closing loopholes and to level field ground for all economic sectors and productive activities. For its depth and potential consequences to attain revenue collection goals, it stands out the Integral Fis- cal ReformBill (IFR) introduced to Congress in the early stages of President Fox term. Though some of the proposals contained in the IFR were actually approved and implemented, the core part of it, which basically included a broad-based new VAT structure, is still pending. Given the immediate and unavoidable fiscal pressures faced by the Mexican Government in the short term, it is expected that new tax reforms initiatives, covering similar issues proposed by the IFR, will be introduced again to Congress by newly elected Federal Government authorities. In this sec- tion, some of the main IFR proposals pending, along with some considerations about under way efforts to modernize the SAT operational system, are laid out.
Value Added Tax
As discussed along the present study, the wide and numerous exemption and zero-rated goods and services items considered in the VAT law, have resulted in a significant reduction of the po- tential consumption base. The narrow-based structure has also contributed to low compliance levels, as taxpayers have found the way to arrange transactions in such a way that they appear either exempt or zero-rated. The IFR proposed a new VAT legislation, though keeping intact a substantial part of the current law articles in order to facilitate compliance. Zero rate was only granted for export activities, under destination principle considerations. For control purposes, the initiative required taxpayers to engage in electronic transfer of funds when arranging for the ex- port transaction payment, to be eligible for VAT refund. The proposed VAT base included most items currently zero-rated or exempt, such as food, medicine, books, magazine, education, and transport. Exempt treatment was only granted to those transactions that, by their intrinsic nature,
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do not represent consumption expenditure, or entail difficult to tax goods and services, such as the sale of land, hard currency, stocks, gold, jewelry, art objects, and financial services, except for interest paid on individual final consumption. Lease or sale of housing construction was also proposed to be exempt from VAT.
The general tax rate proposed by IFR was equal to the current 15 percent, maintaining the reduced 10 percent rate for transaction of goods and services along the border with the US. The rationale behind proposing to leave the dual tax rate system was to avoid market price distortions in the referred area, given the considerable influence of the US southern economy in the living of residents in the Mexican border states. However, the reform proposal maintained the current ex- clusion of the reduced border rate to the taxable sale of fixed property. Some of the IFR original proposals for VAT reform where adopted in an effort to streamline the current structure. The ob- ligation for taxpayers to fulfill an annual tax return, besides provisional monthly payments, was repealed. Nowadays, a monthly taxable period prevails, easing tax administration and compliance costs. Also, in an attempt to simplify tax assessment, facilitate inspections, and allow neutrality respect to the decision of firms to handle commerce practices with suppliers and clients, the VAT time of supply rules switched to pure cash flow basis.
Personal Income Tax
Besides low revenue-yield capacity, the Mexican PIT structure shows serious deficiencies in terms of efficiency, equity and simplicity. The adoption of broad exemptions grounded on poor social or economic justifications, promotes low personal saving rates and productive investment disincentives. Consequently, the PIT system has unnecessary adapted relative high marginal tax rates to medium level income individuals, along with arbitrage opportunities to evade the tax burden. The IFR addressed most of these insufficiencies by followed a basic approach: to broaden the tax base and reduce marginal tax rates. To achieve these objectives, the IFR pursued to wide up the tax base, along with a decrease of marginal tax rates which included the introduc- tion of the zero percent marginal tax rate for the lowest income end.
One of the top priorities of the PIT in the future reform agenda is the tax treatment of fringe benefits into the wage earners tax base. As discussed before, the exclusion of this item from taxable income, which accounts for an estimate of one-third of total wage remuneration, biases the distribution of the tax burden among individuals at the same level of wage income, but
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with different composition. Full taxation of fringe benefits would not only bring revenue and eq- uity benefits to the PIT structure, but also simplicity. The inclusion of this item into the wage earners taxable income makes no longer necessary to sustain the fiscal subsidy system, arranged for those individuals receiving a smaller portion of their salary by fringe benefits. By applying a single marginal tax schedule, instead of two, the PIT regime will get rid off one of its most ad- ministrative complex features. Therefore, a single effective rate could be applicable to each level of income. Part of the extra revenue collection expected form the inclusion of fringe benefits could be used to reduce marginal tax rates to medium income level individuals, and so effectively increasing incentives for work and capital formation. Pursue to streamline the PIT structure, widen its tax base and further contribute to achieve horizontal and vertical equity, the reform agenda should also eliminate the exemption granted to authorship rights.
Corporate income tax
The current CIT structure allows preferential treatments for taxpayers in specific economic ac- tivities, regardless of their size, ability to pay, or administrative capabilities. Through a combina- tion of tax incentives granted by the simplified regime, such as immediate expense of invest- ments, partial exemption of tax liability (about 45 percent for agriculture), and administrative facilities to fulfill deduction requirements, taxpayers carrying out land transport and agriculture activities afford comparatively lower effective CIT tax rates. As a result, medium and large-sized corporations dedicated to agriculture and transport activities, pay little or no CIT. Preferential regimes granted on an indiscriminative way to a broad range of sectors in Mexico not only seri- ously erodes the tax base, but also promotes economic inefficiency, horizontal and vertical ineq- uity among taxpayers, evasion and elusion opportunities, as well as complications to the tax ad- ministration. The limitation of non-neutralities within the CIT structure represents a necessary condition towards a more transparent and efficient system. Thus, the reform agenda should con- sider to cancel the simplified regime as a mean to eliminate preferential treatment for medium and large firms engaged in transport and agriculture activities. As for small scale taxpayers, it is de- sirable to allow them to comply with the income tax either through the small taxpayer´s regime
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Reform on tax administration
A profound reform on the SAT´s operation and infrastructure is currently underway. The drive to change is oriented towards increasing tax compliance through a comprehensive broadening of the taxpayer universe, and a thorough simplification of payments and tax filing processes.One of the basic components of the ongoing reform effort is the redesign and computerization of key proc- ess. In the recent past, SAT operations relied on fragmented information systems, excessive pro- cedures and lack of integration between operating areas. SAT reforms aim at shifting form an organization based on functions towards a different one operating by processes. To achieve this goal, an improved TI platform is currently under design in order to support newly designed tax administration operating processes, either in substantive areas such as taxpayer services, auditing and collection, or support functions such as human, financial and material resources management. Also, some different efforts to improve tax administration are currently underway, such as a comprehensive fiscal census geared towards improving registration and control of individuals and enterprises engaged in trade or business, the Advanced Electronic Firm which allows tax- payers to fulfill obligations and file tax return by electronic means, and the implementation of the risk management program. Towards the future, important steps should be taken to grant auton- omy status to the SAT agency. The wave of autonomy reforms undertaken by tax administrations of different countries during the last decade, have proven to be relatively successful to provide an institutional framework capable of enhancing operation in developing countries. Besides im- proving corporate governing and allow mid and long term strategic planning scenarios, an autonomous SAT would empower managers with greater control over personnel, funding and budgeting to achieve highest standards of efficiency and quality. A constitutional reform should be passed by Federal Congress for SAT to achieve autonomy.
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