Tax Revenues in Mexico in a Context of COVID-19 Pandemic and Structural Gaps

High revenue collection is widely recognized as a key to the welfare state. In Mexico, however, fiscal reforms have historically been unable to improve collection levels and tax revenues are considered fragile [1, 14]. In a context of profound structural miscalculations [5, 15], reduced revenue collection capacity weakens the state’s ability to undertake strategic actions that would put Mexico on a path of economic development and social well-being.

According to López Pérez and Vence [1], Mexico’s systemically low tax burden makes it the country with the lowest tax collection in relation to GDP of all the OECD countries and places it among the four lowest in Latin America. This limits the state’s capacity to implement income redistribution strategies for both revenue and expenditure or finance public spending on strategic interests, security and social welfare.

Beyond the technical design of the system, state tax reform has been plagued by internal errors and historical failures since the time Mexico achieved its independence, which explains much of the current situation of low tax collection [16]. Additionally, most tax reforms in Mexico and other countries throughout Latin American and the Caribbean were generated during periods of economic reform [17], when temporary, internal phenomena conditioned tax system design [18]. Beteta and Yanes [13] have observed that such outcomes stem from a deep-rooted culture of privilege and the practices, rules and institutions that perpetuate it.

Clearly, these and other factors explain much of the current state of the Mexican tax system and its collection levels. The last tax reform in Mexico (implemented in 2014) failed to meet expectations of progress, and the current government remains indifferent. Mexican tax revenues are among the lowest in the LAC region [1, 19], a situation that conditions public spending performance. According to World Bank data [20], Mexico’s public spending is the fifth lowest in the region (22.4% of GDP in 2020), ahead of the Dominican Republic, Paraguay, Nicaragua and Guatemala (21.4%, 19.2%, 19.2% and 14.9% of GDP in 2020, respectively). Mexico ranks third lowest in public spending on health (6.2% of GDP in 2020) among OECD member countries. For the same period and indicator, the United States ranked highest (17.8%), followed by Germany (12.8%), France and Austria (12.2%) [21].

Thus, even in pandemic conditions, Mexico has continued to pursue a restrictive policy and a short-sighted strategy that relies on the recent and historical counter-cyclical policy of the United States [22]. The fiscal measures implemented (approximately 1% of GDP in 2020 [4, 23, 24]) were the smallest of all Latin American countries, demonstrating behavior similar to that of most African countries. As a result, the measures implemented lacked the scope and financing to cope with the immense needs generated by Covid-19 [4].

In a tragic downward spiral the structural gaps accentuated the negative effects of the pandemic [25, 26], creating a health crisis that in turn affected economic and social dimensions. Employment plummeted and poverty reduction was undermined as economic, social and environmental asymmetries worsened [26]. In Mexico, poverty increased at an accelerated rate due to the effect of containment measures on the economy and employment. CONEVAL [11] estimates indicate that extreme income poverty could increase by 4.9 to 8.5%, affecting 6.1 to 10.7 million people during the pandemic period.

Covid-19 infection frequency, severity and lethality was unevenly distributed and had greater impact on historically disadvantaged layers of society [26, 27]. The shock of the pandemic also affected the balance of supply and demand: as businesses were forced to close, supply shrank sharply and demand plunged even lower [22]. Informal economies were more vulnerable to contagion in the absence of health protection and levels of violence and insecurity became increasingly worrying.

The empirical analysis described here is based on the assumption that high levels of tax revenue would allow Mexico to apply fiscal tools and instruments for economic development and the management of extraordinary social and health contingencies such as the Covid-19 pandemic. This would include the direct impact on the public health system as well as economic paralysis, as occurred in 2020 and to a lesser extent in 2021. Accordingly, the analysis looks at the evolution of tax collection over the last decade, the impact of the Covid-19 crisis, tax structure trends and Mexico’s unfinished business in a context of social vulnerability.

The Mexican economy grew at an average annual rate of 1.9% from 1982 to 2020 and GDP by 0.32% for the same period [22]. The Economic Commission for Latin America and the Caribbean (ECLAC) [23] reported that in 2020, the Covid-19 pandemic caused Mexico’s GDP to contract 8.3% in real terms and with original series (compared to 0.2% in 2019). This figure represents the largest fall in the country’s economic activity since 1932. The fiscal deficit of the non-financial public sector rose to 2.9% of GDP (compared to 1.6% in 2019) and the 2020 target was abandoned. Mexico’s fiscal reform remains enigmatic, ineffective and weakened by crisis events, leaving public expenditure needs unresolved.

The 2010-2021 series indicates a slightly volatile tax structure across all revenue categories. Income tax (ISR), Value Added Tax (IVA), Special Tax on Production and Services (IEPS) and Social Security Contributions made up an average of 78% of total revenue. The revenue collection trend showed a decline in the final years, but the 2021 budget target proposed under the Law on Federation Income (LIF) was achieved [27, 28]. At the end of the period, total tax revenues represented just 15.59% of GDP in 2021: higher than the average 14.1% of GDP (2010-21), but lower than the 2016 maximum of 16.5% of GDP (Figure 1).

It is worth noting that despite the events related to COVID-19, revenue collection in relation to GDP grew 1.03% from 2019 to 2020 (Table 1, Table 2). Obviously, the cause lies in both increased revenue collection and the sharp contraction of GDP. The government strengthened collection capacity by applying technical and regulatory measures to eliminate the universal VAT offset, establishing a tax on digital services and combatting evasion practices. However, cautiousness of these tax changes combined with IEPS fuel subsidy policy reversals and the overall effects of the economy led to a decline in the 2021 results.

The evolution (base 100=2015) of revenue collection in absolute values shows a positive progression of tax revenues in 2021. Revenues rebounded from 140% in 2020 to their peak level of 149.34% in 2021 (Figure 2) and were manifested in all tax categories except the IEPS. Income tax increased markedly from 136.38% in 2019 to 142.4% in 2020 and continued to climb to 153.18% in 2021. VAT was more intense between 2020 (139.64%) and 2021 (158.89%) and in absolute terms exceeded one trillion pesos for the first time (SHCP & SAT), 2022).

Increased revenue collection amidst intense economic contraction resulting from the pandemic is a very relevant fact that reveals a notable improvement in collection efficiency.

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Figure 1. Structure (left axis) and Evolution of Tax Revenues in % GDP (right axis), 2010 – 2021

Source: SAT Open Data [29], SHCP Statistics [30] and INEGI [31].

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Figure 2. Evolution of revenues by tax type in absolute values (millions of pesos). Base index 100=2015

Source: Based on SAT Open Data [29], SHCP Statistics [30] and INEGI [31].

IEPS revenues continue to serve the policy of subsidies (incentives) for gasoline, diesel and fuel-oil. This has been the prevailing strategy since the 1980s, when the IEPS replaced the 1974 sales tax on gasoline [1]. The slump depicted in the IEPS corresponds to 100% subsidization of the contributions for gasoline and diesel [32]. The variation between budgeted and actual IEPS revenue was -21.8% in 2021, reflecting a drop from 96.59% of the base index (100=2015) in 2020 to 76.09% in 2021 (Figure 3).

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Figure 3. Evolution of tax revenues by tax type as % of GDP. Base index 100=2015

Source: Based on SAT Open Data [29], SHCP Statistics [30] and INEGI [31].

The analysis of public expenditure data for this period offers a complementary view. Total public expenditure was very modest compared to other OECD countries and had been declining relative to GDP since 2012. Then it increased significantly from 20.35% of GDP in 2019 to 22.38% in 2020, (Figure 4). Admittedly, this increase was due to both the increase in total expenditure and the contraction of GDP in that pandemic year. In any case, the increase in public expenditure exceeded the increase in revenue that year, causing the fiscal deficit to increase. This trend was observed in all OECD countries and Mexico was actually among those with the smallest deficit increase. It continues to have one of the lowest fiscal deficits and has contained public debt issuance.

However, this is all a matter of perspective. Although Mexico’s health spending was the third lowest of all OECD countries, the effort made in the period under analysis cannot be underestimated. In 2020, government and voluntary health expenditure soared past its average of 5.6% of GDP to reach a historic 6.24% (Figure 5) in response to the pandemic emergency.

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Figure 4. Total expenditure and health expenditure in Mexico as % of GDP, 2010 – 2020

Source: DataBank [20], OECD [21].

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Figure 5. Trend in health expenditure (by financing schemes) as % of GDP

Source: OECD [21, 33]

Note: Government refers to mandatory financing schemes and Voluntary refers to direct household payment schemes.

This study makes a brief discussion and critical balance of the level of tax revenues and the capacity of the State to act in the time period of the coronavirus pandemic. However, despite being limited to that short period of time, it is important because it allows us to highlight some structural weaknesses of the Mexican fiscal system and the need for important fiscal reforms in Mexico to improve the welfare system of Mexican society.

Some issues that will require additional work is the analysis of the great inequality existing in Mexico and its consequences for the advancement of a robust taxation for an advanced welfare system. The work has shown the progress in tax collection through the prosecution of fraud and evasion; well, it is important to further analyze this aspect and the type of measures that could reduce this serious structural problem. The analysis of the different types of tax benefits in the major taxes is also necessary for this purpose.