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MEXICO CITY (Reuters) - Tax breaks for attending "civic values" courses, tax-free sales of second-hand furniture, special treatment for call centers and an informal economy employing six out of 10 workers are all in the line of fire as Mexico prepares a long-awaited tax overhaul.
An analysis of budget data shows Mexico's extensive network of tax breaks and stimulus programs generate costs equal to about half the taxes actually collected.
Mexico has the lowest tax revenue in the 34-nation Organisation for Economic Co-operation and Development, crimping its ability to spend on health, infrastructure and social programs vital to boost living standards and growth in what is Latin America's second-largest economy.
Finance Minister Luis Videgaray has given few details of the overhaul, due to be presented in the autumn session of Congress, but has promised it will be "large," reviewing both direct and indirect taxes and making those who earn more, pay more.
Currently, the world's richest man, Carlos Slim, is in the same tax bracket as a worker earning $2,700 a month, paying 30 percent income tax - low compared to top rates of 39.6 percent in the United States, 45 percent in Germany and 50 percent in Japan.
No data is available on revenue by tax bracket, but most of the poor live and work in a shadow economy that accounts for one-third of gross domestic product (GDP) and pay little tax.
That leaves a high burden on middle-income earners.
The narrow tax base, along with a complicated tax code and rampant evasion, capped gross tax revenues at just 9.7 percent of GDP in 2012.
The reform will aim to boost that and ease the country's reliance on oil revenues, which account for nearly 40 percent of government income and make it vulnerable to market swings.
OECD head Angel Gurria, a former Mexican finance minister, still shudders at the memory of the Asian financial crisis in 1997 and 1998, when benchmark oil prices fell as low as $8 per barrel, half the level the government had budgeted for.
"One day when I was finance minister I came into the office at 9 a.m. and the budget deficit was at 0.5 (percent of GDP) and by the time the day was over it was at 3 percent," he told Reuters in January.
Although Mexico has a balanced budget and optimism about the government's reform agenda is drawing a surge in foreign investment, ratings agencies say the skimpy tax base and oil dependence have been hurdles to a sought-after upgrade, especially as oil output has dropped by a quarter since 2004.
Standard & Poor's changed its outlook on Mexico's BBB-rating to positive in March, suggesting an upgrade is possible within 18 months, but S&P credit analyst Joydeep Mukherji said the scope of the fiscal reform would be key.
"If it's basically a relatively small impact and kind of gets washed out among other things, it won't have a big impact and we may not upgrade," he said. "You can't rely forever on that much money from the oil sector and such high oil prices."
Mexico's net tax income, taking the negative impact of fuel subsidies into account, was worth just 8.5 percent of GDP last year.
Total government revenue, including oil, averaged 18 percent of GDP in the last decade, compared to 26 percent in the United States, 32 percent in Brazil and more than 40 percent in some European countries, OECD data show.
Experts estimate Mexico must boost its tax intake by 6-8 percentage points of GDP, or about $100 billion a year to reduce its reliance on oil revenues and fund increased government spending, although the reform could start out netting half that amount and be ramped up progressively over coming years.
Measures to bridge the gap could include increased efforts to tackle tax evasion, worth 2.57 pct of GDP in 2007 according to the Monterrey Institute of Advanced Technological Studies.
Other options are raising top personal tax rates for the rich; making state governments levy more tax; imposing taxes on capital gains, inheritances and property transfers; and scrapping an entrenched zero rate of value-added tax (VAT) on basic food and medicine.
This last exemption is the biggest single contributor to tax breaks worth 4.8 percent of GDP in 2012, equivalent to about half of tax revenues. Mexico's ratio of tax breaks to revenue is similar to the United States but more than in Germany, Spain and South Korea, a sign of the complexity of its tax code.
One tax break the government has vowed to end is consolidated reporting for firms, which allows companies to set losses in one business against gains elsewhere - a practice critics say is easily abused.
Total discounts and deductions, listed in a 117-page budget document, include special tax regimes which mean many family firms and self-employed workers pay no income tax or VAT, and allow individual deductions for medical expenses, school fees, some share purchases and courses which promote "civic values," while VAT discounts and exemptions span items from gold ingots to lottery tickets, medical services and table water.
The governing Institutional Revolutionary Party (PRI) has taken a step towards breaking the taboo of no VAT on food and medicines by removing a ban on such a move from its statutes, although insiders say staples such as tortillas and beans may remain exempt, or be charged at a low rate, such as 3 percent.
Many Mexicans shop for groceries at canvas-covered farmers' markets and buy anything from chewing gum to calendars from roving street vendors, none of whom pay or charge tax.
"You have to revise the zero rate," said Ernst & Young partner Herbert Bettinger, who has advised the PRI on past tax reforms. "You can leave it on food, but everything else should be removed."
However, extending VAT to products currently exempt is a sensitive political issue and the government may struggle to win support from opposition parties and even some lawmakers inside the PRI.
The Mexican Institute of Chartered Public Accountants (IMCP) says tackling the informal economy must be one of the priorities of the new regime, which the government hopes will be passed together with the 2014 federal budget and take effect next year.
The IMCP, which would also like to scrap a 'flat tax' option for firms and lower the corporate tax rate from the current 30 percent, estimates that taxing all informal workers would boost the tax take by 3 percentage points of GDP.
"The 10 percent (of GDP) tax that Mexico does raise, it raises from 40 percent of the economy because 60 percent of workers are informal and don't pay tax," said IMCP president Carlos Cardenas. "We can't do a fiscal reform just for that 40 percent."
($1 = 12.0933 Mexican pesos)
Additional reporting by Thomson Reuters' service Dofiscal and Pablo Garibian; Editing by Kieran Murray and David Brunnstrom