The distributional impact of reforms to direct and indirect tax in Mexico: methodological issues and approach

In 2010, the Mexican government implemented a fiscal tightening through an increase in VAT, the financial deposit tax, and a temporary increase to the top rate of income tax. This differed significantly from earlier proposals for a more significant tightening and reform that were rejected by the Congress. When assessing both the proposed and approved reforms, an important element of any appraisal is to ascertain the distributional impact of the tax changes. This paper lays out the methodological issues involved in such an exercise and describes the approach the authors will take in their analysis. It is the first paper of a study aimed at building capacity for the distributional analysis of tax reform in Mexico through, in part, the development of a micro‐simulation tool, MEXTAX.

The Mexican context presents a number of challenges for such distributional analysis. First, is the high degree of economic informality and tax evasion meaning that the actual tax burden is significantly less than the legislated burden. Second is that the quality of income data in available surveys are poor relative to developed economies (although superior to that available in most developing countries). Finally, there is a relative paucity of estimates of the behavioral response to taxation in Mexico.

The methodology that shall be adopted for this study will make heavy use of robustness analysis to test the sensitivity of results to different assumptions about informality, tax evasion, missing income and behavioral response. The response of consumers to changes in VAT will be assessed using a consumer demand model, and an attempt will be made to analyse the decision of whether to work formally or informally. Rather than attempt to simultaneously model all behavioral responses simultaneously, different margins will be modelled or simulated independently.

The need for future work on behavioral response and suggested fruitful avenues for research are highlighted.