VAT Collection and Social Security Contributions: Is There a Link?

Mexican public finances are weak; national tax collection as a percentage of GDP is among the lowest in the world. On the other hand, expenditure needs are enormous. There have been several attempts to reform our tax system but they have not been successful due to different factors such as political interests, excess of oil revenues, and deficient design of the reforms. One of the most important problems is that every reform has been attempted with no significant change on the expenditure side, or what is more, ignoring links between taxes and other economic areas such as social security contributions. Recently Levy (2008) has proposed a major change on the expenditure side. In particular he argues that social policy should dramatically be modified to be able to provide a universal health care system together with unemployment insurance, which at the end would promote formality. This calls for an adequate financial source. In this work we estimate the potential VAT collection to finance this proposal, taking into account some partial equilibrium effects in a context of coexistence of formality and informality. Here the former is defined in terms of tax compliance only.