On Sunday Mexican President Enrique Pena Nieto presented a fiscal reform package that abandoned previous efforts to raise sales taxes on food and medicine in favor of increased taxes elsewhere. Though there will be political maneuvering in the months to come, some version of the new bill will likely pass with the support of Mexico's left wing party, the PRD. Ultimately, there is broad consensus that tax reform is necessary to partially compensate for declining output and upcoming regulatory changes in the country's energy sector, which will collectively reduce government revenues going forward.
Amid a host of proposed changes, Pena Nieto's plan aims to increase tax intake by 2.9 percent of GDP by 2018. To do this, he has proposed raising capital gains taxes and closing tax loopholes. It will also raise income tax for individuals making more than 500,000 pesos a year, or just under $40,000. This will primarily affect Mexico's upper classes. Social reforms are also in the plan, incentives to business owners to formalize workers foremost among them. With the increased revenue, the Mexican government hopes to finance infrastructure development alongside improvements in health care and support for unemployed and seniors.
As we have discussed previously, Mexico's energy sector is in rapid decline. Although the government hopes to turn this decline around with pending reforms to the sector that will allow for foreign participation, one of the major challenges still facing the sector are high government taxes on the state owned oil company Pemex. The company supplies between 30 and 40 percent of the government budget in any given year, which is an enormous drain on the company's resources and a severe handicap on its ability to pursue oil and natural gas production in increasingly challenging deposits.
It is, in part, this heavy dependence on Pemex that has allowed Mexico to put off addressing very fundamental social and economic issues. In the lead up to the unveiling of Pena Nieto's plan this week, there had been broad discussion about the possibility of an increase in sales tax on food and medicine. Perhaps needless to say, such a move would have been highly unpopular among Mexico's majority poor and middle class. However, a higher sales tax would have raised more revenues for the government and would have taken pressure off business revenues.
A sales tax also would have been a much easier tax to collect than an income tax, and this is where perhaps the most critical aspect of the new law comes in. According to government surveys, 60 percent of Mexico's total workforce is made up of "informal" workers. These workers do not pay taxes, are not included in the national safety net and form a large part of Mexico's enormous underground economy. Proposed incentives to encourage employers to formally register their workers as well as reaching out to incorporate the large numbers of self-employed individuals will be critical to watch going forward. Mexico's ability to leverage any income tax at all requires that workers be known to the government. And despite the fact that most informal workers are estimated to be extremely poor, over the long run, incorporating workers into the taxation system will be critical for future efforts to move away from oil as the main driver of government spending.