VZCZCXRO0925
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #5044/01 2612007
ZNR UUUUU ZZH
P 182007Z SEP 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 8907
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 04 MEXICO 005044 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR A/S SHANNON 
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH 
STATE FOR EB/ESC MCMANUS AND IZZO 
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD 
USDOC FOR ITS/TD/ENERGY DIVISION 
TREASURY FOR IA (ALICE FAIBISHENKO, ANNA JEWEL) 
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD 
NSC FOR RICHARD MILES, DAN FISK 
STATE PASS TO USTR (EISSENSTAT/MELLE) 
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) 
 
E.O. 12958: N/A 
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: MEXICAN CONGRESS APPROVES LONG-SOUGHT TAX REFORM 
 
REF: A. MEXICO 4970 
     ¶B. MEXICO 4815 
     ¶C. MEXICO 4552 
     ¶D. MEXICO 4282 
     ¶E. MEXICO 4280 
     ¶F. MEXICO 4236 
     ¶G. MEXICO 4191 
     ¶H. MEXICO 4151 
     ¶I. MEXICO 4015 
     ¶J. MEXICO 3246 
     ¶K. MONTERREY 725 
 
¶1. (SBU) SUMMARY:  Mexico's Senate approved an overhaul of 
the country's tax laws on September 14 -- a move that will 
strengthen public finances and give President Calderon 
another legislative victory.  The Chamber of Deputies has 
already approved the bill, so most of the reforms only 
require the Executive's signature to be published in the 
Official Gazette and become law.  The reform introduces an 
alternative minimum corporate tax, creates a tax on cash 
deposits, increases the gasoline tax by 5.5%, and enacts some 
measures to strengthen tax collection.  The reform will boost 
government revenues by 1.1% of GDP in 2008, a figure that 
gradually increases to 2.1% of GDP by 2012.  While the scope 
of the reform is limited, it is a step in the right direction 
and it sends a positive signal regarding Calderon's ability 
to pass other economic reforms.  END SUMMARY. 
 
¶2. (U) Mexico's Senate approved an overhaul of the country's 
tax laws on September 14 -- a move that will strengthen 
public finances and give President Calderon another 
legislative victory.  The Chamber of Deputies has already 
approved the bill, so most of the reforms only require the 
Executive's signature to be published in the Official Gazette 
and become law.  A few measures related to the supervision of 
public accounts must pass through state legislatures since 
they entail changes to the constitution. 
 
¶3. (U) Under Secretary of Finance Alejandro Werner remarked 
publicly that the reform will have a direct impact on public 
finances and will promote greater economic growth. 
Government officials expect the measures to increase real GDP 
growth in 2008 from 3.5% to 3.7%.  Werner added that the 
passage of the bill sends clear signals to domestic and 
foreign investors that Mexico has begun to work on a more 
solid and competitive economy.  Werner added that the bill 
opens the door for movement on labor, energy, and educational 
reform. 
 
¶4. (U) The reform will boost government revenues by 1.1% of 
GDP in 2008, a figure that gradually increases to 2.1% of GDP 
by 2012 (vs. 1.5% and 2.8%, respectively, in the original tax 
proposal).  Note that these figures do not include the 
effects of a tax hike on gasoline or a tax cut for Pemex. 
When a new tax on gasoline is excluded, approximately 70% of 
the additional resources will go to the federal government 
and 30% to the federal entities.  Calderon has pledged to use 
the extra federal resources for infrastructure, education, 
and health programs. 
 
-------------------------- 
Key Components of the Bill 
-------------------------- 
 
¶5. (SBU) Large parts of the reform proposal the 
administration unveiled in June remained intact, but the 
government was forced to make a number of concessions to 
appease business and interest groups to secure backing from 
the opposition.  Some of these changes watered down the bill, 
while others were improvements. 
 
Public Revenues 
--------------- 
 
MEXICO 00005044  002 OF 004 
 
 
 
¶6. (SBU) The heart of the bill is an alternative minimum tax 
called the Single Rate Corporate Tax (IETU for its initials 
in Spanish), which is intended to respond to criticism of 
loopholes companies in Mexico use to significantly lower 
their tax bill.  Werner has said publicly that congressional 
changes to this tax have made it more "friendlQo 
investment.  The tax, which allows fewer deductions than the 
regular income tax, will be set at 16.5% next year and will 
rise to 17% in 2009 and 17.5% in 2010 (vs. 19% in 2010 in the 
original proposal).  Salaries will generally be creditable 
under the IETU, and employee benefits will generally be 
deductible.  New investments made in the fourth quarter of 
this year will be deductible over the next three years.  For 
investments in fixed assets, deferred expenses and charges, 
the bill grants a tax credit against the IETU at a rate of 5% 
during the next 10 years.  The proposal also allows tax 
deductions for charitable donations (with some restrictions) 
as well as deductions for private schools and small 
agricultural producers.  According to the Department of 
Treasury's Tax Policy Office, the USG and GOM have been in 
discussions regarding the creditability of the IETU against 
U.S. income taxes but have not made any public announcement. 
 
¶7. (SBU) A 20% excise tax (IEPS) on gambling and lotteries 
was approved, while a proposed tax on aerosol paints was 
rebuffed.  The bill repeals the Assets Tax (IMPAC), and 
removes tax exemptions on stock sales that involve a change 
of control of a company, or the sale of more than 10% of a 
company's stock in a 12-month period.  Mexican Stock Exchange 
Deputy Director General Pedro Zorrilla said publicly that the 
change will not inhibit investment, noting that the benefits 
of financing through the stock market will offset any 
negative impact.  Edgar Camargo, the Head of Economic 
Research at Bank of America in Mexico (strictly protect 
throughout), told econoff that while at first glance this 
change may raise concerns, it "is not a big deal" since it 
only affects "very large amounts of money."  Referencing the 
mergers of BBVA and Bancomer and Citibank and Banamex, he 
said the government is trying to avoid large transactions 
taking place tax free. 
 
Tax Cut for Pemex 
----------------- 
 
¶8. (U) Legislators also approved measures that will free up 
more cash for Pemex to invest to stem declining oil 
production.  The rate on the ordinary fee on hydrocarbons is 
reduced from 79% currently to 74% in 2008, and it falls to 
71.5% by 2012.  The move cuts USD 2.7 billion from Pemex's 
tax bill in 2008 and USD 5 billion by 2012.  The reform 
boosts the amount of resources dedicated to scientific and 
technological research, and it requires Pemex to carry out a 
program to increase its operational efficiency, following 
approval from the Secretariat of Energy. 
 
¶9. (SBU) Camargo remarked that the PRI pushed for these 
measures because it wanted to make sure Pemex received a part 
of the additional resources from the tax reform and because 
it wanted to strengthen its links to one of the country's 
most important unions.  He remarked that he was not 
particularly pleased with the initiative, but that he would 
wait and see if Pemex spent the money wisely.  Hacienda 
officials on several occasions have told econoffs that they 
wanted to improve Pemex's efficiency and transparency before 
giving the company more resources. 
 
¶10. (SBU) That said, many industry analysts argue that the 
measures provide much-needed tax relief since Pemex's high 
tax bill leaves it with little to devote to exploration and 
refining.  Mexico already imports 40% of its refined oil 
products, and its oil reserves are expected to fall over the 
next decade. 
 
MEXICO 00005044  003 OF 004 
 
 
 
Tax Administration 
------------------ 
 
¶11. (U) The bill levies a 2% tax on cash deposits exceeding 
25,000 pesos (USD 2,294) per month, an attempt to attack tax 
evasion in Mexico's vast informal economy.  This "Tax on Cash 
Deposits" is creditable against the income tax and other 
federal contributions.  It will become effective on July 1, 
2008 to give banks time to prepare their systems to collect 
the tax.  Most remittances as well as payments made in cash 
to repay loans granted by financial institutions are not 
subject to the tax. 
 
¶12. (U) The majority of Calderon's proposals to strengthen 
auditing and control procedures were approved.  In 
particular, Congress is given more power to audit federal 
transfers to the states; fines to advisors and service 
providers are increased; shared responsibility is established 
when a firm changes its address without proper notice; and 
new rules are established regarding a taxpayer's obligation 
to provide authorities documentation during an audit. 
 
Fiscal Federalism 
----------------- 
 
¶13. (U) The bill enacts a 5.5% increase on federal gasoline 
and diesel taxes, the proceeds of which will go to state and 
municipal governments for investment in infrastructure 
projects.  The planned rate hikes will be implemented over an 
18-month period.  This tax is transitory and will be 
suspended if a (failed) proposal that would have allowed 
federal entities to levy products subject to the federal 
excise tax (IEPS) is approved at the local level, and any 
state incorporates the local sales tax.  HSBC economist 
Alejandro Martinez (strictly protect throughout) told econoff 
the reform package "does almost nothing" to improve fiscal 
responsibility and transparency at the state level.  He added 
that the states were the biggest winners of this reform 
because they secured additional income without having to 
assume the political costs of raising taxes. 
 
¶14. (U) The bill creates two funds: the Hydrocarbon 
Extraction Fund for states where oil is extracted, and the 
Compensation Fund for the 10 states with the lowest 
non-mining and non-oil related GDP per capita.  The latter, 
which aims to direct resources to the poorest states, will be 
financed with approximately 20% of the revenues from the new 
gasoline tax. 
 
Public Spending 
--------------- 
 
¶15. (U) The bill stipulates that the Executive Branch must 
reduce its operating and administrative expenditures by 5% 
per year in coming years, with a final goal of trimming 20%. 
In lieu of creating a National Council of Public Policy 
Evaluation, the bill established general principals that will 
be the basis of performance evaluations made by public 
institutions that have this function.  The reform also 
requires government-owned companies to create "austerity 
programs," and it promotes greater competition in government 
acquisitions. 
 
¶16. (U) It is worth noting that a few measures regarding the 
supervision of public accounts entail changes in the 
constitution, and therefore must be approved by local 
legislatures.  The Chamber has approved these measures, but 
the Senate has yet to ratify them. 
 
-------------------- 
Reaction to the Bill 
-------------------- 
 
MEXICO 00005044  004 OF 004 
 
 
 
¶17. (SBU) Some local pundits have highlighted the many 
concessions the government made to secure the opposition's 
backing for this reform.  They note that the final reform 
bill is "too little" and that it came at too high a price. 
Alejandro Martinez remarked that market followers are already 
asking how much Calderon will have to concede to secure 
passage of more difficult initiatives, such as energy reform. 
 Some business leaders continue to argue that the new 
measures will hurt investment and economic growth. 
 
¶18. (SBU) Most market observers, however, agree that while 
the reform is limited, it is a step in the right direction. 
Camargo told econoff the reform sends a positive signal 
regarding Calderon's ability to govern and pass other 
economic reforms down the road.  He underscored that it was 
not simply the passage of the reform, but rather the fact 
that Calderon was able to advance his agenda while working 
with the opposition in Congress.  From his point-of-view, it 
is better to have passed a slightly less ambitious reform 
that kept "the channels of communication open," than to have 
secured approval of the government's initial proposal but 
left severe divisions among political parties. 
 
¶19. (SBU) Camargo told econoff that the reform will probably 
lead Standard & Poor's to upgrade Mexico's sovereign rating 
by yearend.  He noted that other factors, including the heat 
rating agencies have taken for not warning about trouble in 
the sub-prime market, could delay the expected outcome. 
While an upgrade would not result in a huge market rally, it 
would be welcome news to financial markets.  Martinez was 
slightly less optimistic, noting that he expected the upgrade 
in early 2008. 
 
------- 
Comment 
------- 
 
¶20. (SBU) The tax reform bill should be seen for what it is, 
a first step forward.  The approval of this reform represents 
another victory in Congress for Calderon and an important 
step for a country that has not approved any significant tax 
reform measures in a decade.  Importantly, the reform will 
help Calderon address falling oil production and keep pace 
with rising health and pension commitments as Mexico's 
population ages.  This reform opens the way for the 
administration to push other much-needed initiatives, such as 
streamlining its cumbersome legal system, improving its 
educational system, and undertaking labor and energy reform. 
End Comment. 
 
 
Visit Mexico City's Classified Web Site at 
http://www.state.sgov.gov/p/wha/mexicocity and the North American 
Partnership Blog at http://www.intelink.gov/communities/state/nap / 
GARZA