Mexico | Economic recovery by reducing the income tax rate for low-income taxpayers

  • Despite the reduced fiscal space, we consider it desirable to boost private consumption and, by the same token, aggregate demand by reducing the target for the 2019 primary balance to 0.5% of GDP
  • We suggest that this be implemented through a reduction in the income tax rate in such a way that it benefits taxpayers at low-income levels, which have a higher marginal propensity to consume
  • To avoid that such fiscal stimulus brings about a permanent reduction in the tax revenue derived from income taxes, we suggest public policies aimed at lowering the informal sector’s size and thus make it possible to have a significantly broader base of taxpayers in the years to come

We believe that the economic recovery plan announced by the Ministry of Finance several weeks ago will have a positive marginal impact on economic growth in 2019. This is mainly the case because 66% of the plan's resources are allocated to the provision of loans and guarantees of development banks. Although the plan aims to boost the productive activity of micro-businesses and small and medium-sized enterprises, the full amount of credit granted will depend on these companies' demand for credit and, ultimately, on the demand for the goods and services they produce.

As we estimate there is a low probability that commercial banks apply credit rationing to those companies and in our view the relatively low banking penetration is due to demand and not to supply problems, we believe that there would be relatively low demand for such credits unless credit risk admission standards were relaxed. The latter would result in financial losses for development banks and, in the case where their equity would fall below the minimum level, public finances would be under pressure.

In our view, it would be more effective that the fiscal stimuli package be concentrated on the development of infrastructure projects. This is mainly due to their higher impact on potential economic growth because of the positive externalities that they could produce. For such type of package, we propose the creation of an autonomous institution that oversees the financial and social valuation of public investment projects. Consequently, the risk of approving such projects only because of political considerations would be mitigated. Given that Mexico does not have an institution of this nature, the fiscal stimulus that we will describe next will revolve around paying lower taxes.

As we know, economic growth in Mexico is experiencing a slowdown that has been reflected on the stagnation of productive activity since the fourth quarter of last year. Moreover, the pace at which formal employment is created has been in significant decline from an average annual growth rate of 3.5% in the fourth quarter of 2018 to 2.4% in the second quarter of this year. In the meantime, the figures for the annual variation of the private consumption indicator in the domestic market were 1.4% for the fourth quarter of last year and 0.8% for the months of April and May. Finally, GDP showed an annual growth of 0.3% in the first half of the year. Our annual GDP growth forecast for 2019 is 0.7%.

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