Mexico dilutes fiscal reform as plan dodges sales tax

By Dave Graham and Alexandra Alper

MEXICO CITY (Reuters) - Mexico's government on Sunday proposed raising taxes for higher earners, putting a levy on stock market gains and boosting social programs to help the poor, but it shied away from widening a controversial sales tax amid an economic slowdown.

The planned fiscal reform includes a universal pension and unemployment insurance in a country where half the population lives in poverty, as well as emergency spending that will bring on a budget deficit this year and next.

Applying the sales tax to food and medicine is a political hot potato in Mexico, and its omission will dilute the potential impact of the reforms because it was seen as one of the most effective ways of raising more revenue.

Avoiding that tax, which senior figures in the ruling Institutional Revolutionary Party (PRI) had until recently said looked almost certain, should help blunt street protests by leftists who say it would be unfair on the millions of poor.

Much of the social burden for the reform appears to fall on the middle class, with the top rate of tax rising to 32 percent from 30 percent for those who earn more than 500,000 pesos ($37,800) a year, the plan presented to Congress showed.

It also closes some tax loopholes and ends some exemptions.

"The reform puts an end to tax privileges that shouldn't exist," President Enrique Pena Nieto said in a speech at the presidential residence as he unveiled his reform proposals.

"The aim is that all taxpayers without exception ... contribute to the country as far as their means will allow."

Details of the plan sparked prompt criticism from some members of the conservative National Action Party (PAN), which the centrist Pena Nieto has relied on to help push his economic policies in Congress because his PRI lacks a majority.

"To put this rate on those earning 500,000 pesos is an attack on the middle class," said PAN Senator Francisco Dominguez, who sits on the Senate's finance committee.

By contrast, the plan, which also includes measures to tax soft drinks and impose a carbon charge on polluters, won some early applause from Mexico's main leftist opposition party.

The reform aims to increase Mexico's weak tax revenues by nearly 3 percent of gross domestic product (GDP) by 2018 - less than the 4 percent of GDP several senior officials in the PRI had said the government was originally targeting.

Pena Nieto also backed off from imposing much higher income tax rates on Mexico's richest, including Carlos Slim, who started this year as the world's richest man.

Instead, following a surprise contraction in the economy during the April-June period, the government plans to deliver a short-term boost to growth with "emergency" spending which will cause a budget deficit this year and next.

The bill proposes a "transitory" deficit of 0.4 percent of GDP for 2013, and 1.5 percent of GDP in 2014.

STOCK MARKET TAX

Fiscal reform is one of the key planks of Pena Nieto's economic agenda, which aims to improve years of sluggish growth in Latin America's No. 2 economy.

The reform proposes imposing a 10 percent tax on stock market gains and dividends and eliminating some two-thirds of special tax breaks and exemptions. The shared border area with the United States will no longer enjoy a lower sales tax that was originally introduced to help spur trade.

Pena Nieto has pledged to lift growth to around 6 percent a year - up from an average of barely 2 percent since 2000 - by also opening up the oil sector to foreign capital, fomenting competition in major industries and improving education.

The plan aims to ease the tax burden on state oil monopoly Pemex (PEMX.UL), though Pena Nieto did not detail by how much. A draft of the plan foresaw the burden eventually falling to below 60 percent from 79 percent.

That interlocks with a separate energy reform Pena Nieto has presented which seeks to lure foreign investment into the industry to help reverse a slide in crude production.

Mexico wants to wean itself off dependence on Pemex, whose revenues fund about a third of the federal budget. Easing its tax burden should help it to compete better internationally, although it has also been hurt by inefficiencies.

Mexico has the lowest tax revenue in the 34-nation Organization for Economic Co-operation and Development (OECD), crimping its ability to spend on health, infrastructure and social programs vital to boosting living standards and growth.

Excluding revenues from Pemex, the total of taxes raised by the government was only 9.7 percent of GDP in 2012.

ECONOMIC WOES

The government slashed its 2013 growth outlook to 1.8 percent last month after the economy shrank by 0.7 percent in the April-June period. That increased pressure on policymakers to hold back from any measures that could crimp demand.

The government also aims to levy so-called health taxes, including levies on fuels and soda pop, to combat obesity.

It also plans to continue to erase fuel subsidies, with gasoline prices rising in line with inflation from 2014.

Shortly after taking office in December, Pena Nieto forged a pact with the opposition to push for a range of reforms. It has helped him push major legislation to increase competition in the telecoms sector and improve education standards.

Pena Nieto is already grappling with protests by teachers opposed to tougher standards, causing friction between the PRI and the leftist Party of Democratic Revolution (PRD), whose leader Jesus Zambrano also signed the so-called Pact for Mexico.

Zambrano welcomed details of the tax reform on Sunday.

"It seems this would be a big step forward in re-directing the economic policy of Pena Nieto's government," he told Reuters. "It would mean paying heed to a fundamental part of the agreements contained within the Pact for Mexico."

The PRD is opposed to Pena Nieto's energy overhaul, arguing it plans to give away Mexico's oil wealth. But agreement on the tax plan could bring the two sides closer together, possibly smoothing the passage of the energy bill through Congress.

Still, Mexico's most well-known leftist, Andres Manuel Lopez Obrador, the runner-up to Pena Nieto in last year's election, has vowed protests against the reforms.

Thousands gathered at a rally led by Lopez Obrador in central Mexico City on Sunday, though the atmosphere was peaceful. In 2006, his protests over alleged electoral fraud paralyzed parts of Mexico City for weeks.

($1 = 13.2405 Mexican pesos)

(With reporting by Miguel Angel Gutierrez, Anahi Rama, Ana Isabel Martinez, Simon gardner, Michael O'Boyle and Gabriel Stargardter; Editing by Kieran Murray)