Redistributive Impact and Efficiency of Mexico's Fiscal System

Keyword: 
Fiscal Policy
Topic: 
Fiscal Policy - Public and Welfare Economics

This article is part of the Online Forum: The Redistributive Impact of Fiscal Policies

      Over the last two decades Mexico has implemented a series of important spending and policy reforms which have significantly increased the redistributive impact of social spending. These include a strong reallocation of public spending to social programs (from 25% of primary spending in the 1980s to 49% in the 2000s), the introduction of innovative and effectively targeted transfer programs, in particular the Progresa/Oportunidades CCT program, and (largely as an effect of the latter) a general reorientation of basic education services, health services for the uninsured and food subsidies from urban to poor rural areas.

A second wave of reforms over the last decade has increased public spending on non-contributive social protection programs benefiting the poor (with the collateral effect of subsidizing informality), including the introduction and rapid growth over the last five years of basic pension programs (Adultos Mayores, 70 y más) and health insurance (Seguro Popular). The most progressive spending categories at present include most direct transfers and food programs, pre-school and primary education services, and health services for the uninsured.

While these reforms have increased the redistributive impact of Mexico's fiscal system significantly, this still falls well below the country's redistributive potential as measured by its per capita income level, the quality (and redistributive effectiveness) of its best social programs, and the achievements of comparable countries in the region. While Mexico's per capita income is similar to Argentina's and higher than Brazil's, social spending as a share of GDP (10%) is less than half of Argentina's and 60% of Brazil's. The redistributive effectiveness of this spending in Mexico, measured as the percentage change in the Gini coefficient divided by the percentage of GDP allocated to this spending (1.39) is lower than Argentina (2.12) and similar to Brazil (1.37), so the total reduction in inequality which Mexico is estimated to achieve through social spending (14.4%) is 10 and 6 percentage points lower than Argentina's and Brazil's, respectively.

Most of this redistribution is achieved through in kind transfers under the (strong) assumption that the monetary value of these transfers to their beneficiaries is equivalent to the average cost of provision, so it is of particular interest to consider the effect of direct cash transfers. Mexico's direct transfer programs are just as effective in reducing extreme poverty (measured by the 2.5 USD PPP poverty line) as Argentina's, and more than twice as effective as Brazil's. However, Mexico spends only 1% of GDP on such transfers, while Argentina and Brazil spend 3.7% and 4.2%, respectively, so while these transfers reduce extreme poverty by 58% and 28.5% in the latter countries, they do so by only 15% in Mexico.

The failure of Mexico's fiscal system to achieve its redistributive potential, as implied by the country's income level and the highly effective redistributive instruments introduced over the last two decades, is explained by three principal characteristics of this system: a) a progressive but comparatively unproductive tax system, with particularly low levels of indirect tax revenues, b) low spending on direct transfers, and c) a significant share of scarce fiscal resources allocated to instruments with limited redistributive effectiveness. This unfortunate combination is not accidental. Mexico's tax system is at the same time among the most progressive and least productive in the region because it has broad exemptions as well as explicit subsidies often intended to protect the poor, but which are actually among the least effective elements in Mexico's fiscal system in terms of income redistribution. These include: a) generalized exemptions on VAT on foods and medicines; b) a special excise petrol tax which becomes negative when the international reference price rises above the domestic government-set price, which has generated an accumulated subsidy of 6% of GDP over 2006-2012; and c) a negative income tax or employment subsidy for formal sector workers. As any generalized consumer subsidy, especially in a context of high income inequality, most of the benefits from the VAT exemptions and petrol subsidy are concentrated on higher income groups. The negative income tax benefits lower income workers within the formal sector, but these tend to be in the middle of the income distribution as poor workers are generally informal. While some of the benefits from these subsidies do reach the poor, and are indeed more important to the poor than to the rich relative to their respective income levels, what the poor gain from a more progressive tax system is much less than what they lose from the limited transfers this system is able to finance for them.

In addition to these subsidies, other mayor social spending categories benefiting mostly middle- and upper-income groups are subsidies to the contributory social security systems and to public tertiary education, as well as public scholarships other than those of Oportunidades. 

The wide range of concentration coefficients across as well as within the principal policy dimensions analyzed (education, health, social security, income support, food programs), and the large differences in the redistributive efficiency of the principal instruments, reveals significant opportunities to improve the system's overall redistributive impact.

How can we explain the persistence of ineffective redistributive instruments absorbing a large share of fiscal resources? In some cases, this reflects capture of benefits by organized interest groups (agricultural subsidies, subsidies to finance pension and other social security benefits for public sector workers well above benefits available to formal private sector workers), a legacy of 70 years of a single-party corporatist regime. But in the most important cases this is explained simply by the economic costs which households have to incur to access public benefits, which in a context of high (market) income inequality may be enough to exclude the poor. These include (and overcoming them implies): explicit or implicit user fees (shift to tax finance), social security contributions (reduce benefits to increase coverage, or shift to general tax finance), labor opportunity costs of attending public higher education (shift from supply side subsidies to well targeted scholarships), purchasing power for subsidized goods and services (shift to targeted subsidies and direct transfers). Population dispersion, which is exceptionally high in Mexico, acts as a third barrier contributing to both income and fiscal inequality.

Fiscal reforms should always be conceived and implemented integrally, but even more so in the context of Mexico's low revenue/high inequality fiscal equilibrium, or inequality trap. A more equitable fiscal contract would transit from generalized subsidies and a truncated contributive social security system, to a broad tax base financing an effective, universal and well-funded system of benefits.


References

Scott, John. 2013. Redistributive Impact and Efficiency of Mexico’s Fiscal System. CEQ Working Paper No. 8.

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