Analyzing Income Distribution: A Cost-Benefit Analysis of Mexico’s Social Spending

In response to public criticism, the Mexican government increased social spending to redistribute resources and reduce income inequality. In a recent Commitment to Equity (CTE) working paper, “Redistributive Impact and Efficiency of Mexico’s Fiscal System,” John Scott analyzes the efficiency of Mexican redistributive fiscal policies implemented in 2008 and 2010. The author examines various forms of social spending, including cash and in-kind transfers, as well as consumer subsidies. To estimate the effects of Mexico’s tax-benefit system on income redistribution, Scott compares prevailing coverage gaps and living standards between urban and rural populations in the context of their increasing pre-tax income gap.

According to Scott’s findings, social transfers—including public spending on education and health, energy subsidies, direct cash transfers, and small in-kind transfers—are particularly beneficial for poor people living in rural areas of the country. These programs collectively represented 83.3 and 77.1 percent of Mexican government’s social spending in 2008 and 2010, respectively. Indirect energy subsidies, or selling domestic gas at a frozen price, jumped to a record high of three percent of GDP in 2008, but returned to 2.3 percent of GDP in 2011. The author predicts that social spending will decrease if the Mexican economy continues to recover.

Scott notes that a large proportion of increased public spending is financed through oil revenue obtained from the state-owned oil company, PEMEX. Despite repeated attempts to implement tax reforms over the last decade, the Mexican government has not been able to increase its fiscal capacity, as non-oil tax revenues have remained stagnant between 10 and 15 percent of GDP. Ineffective tax collection and multiple income tax exemptions, such as those for agricultural producers, further contribute to low tax productivity in Mexico.

Overall, the report underscores the mixed impact of social spending on the decline in income inequality and poverty reduction in Mexico. Redistributive programs, particularly in-kind transfers in the education and health sectors, successfully reduced income inequality by 15.1 and 15.9 percent in 2008 and 2010, respectively. Mexico also experienced a 16.2 and 15.1 percent reduction in the extreme poverty rate in 2008 and 2010, respectively. But Scott notes that the effectiveness of transfer programs would decline dramatically if they expanded to include pension income. As pension income is a crucial income transfer for the urban poor, Scott speculates that analysts may overestimate the benefits of the Mexican government’s social spending if they fail to account for pensions as one of its major costs of reducing urban poverty.

Mexico’s government faces a tradeoff between poverty reduction and income redistribution. Although the effect on poverty reduction is uncertain in urban regions, Scott’s report indicates that direct transfers and in-kind transfers have a more significant effect on income redistribution within rural regions than in the urban regions. According to his data, there was a 24 percent reduction in the wealth gap between the two regions in 2010, even as indirect subsidies were reduced by 1.4 percent of GDP since 2008. Considering the effectiveness of direct transfer programs, therefore, Mexico’s experience suggests that the compositional shift from indirect subsidies to direct transfers may improve the overall efficiency of a social spending system in terms of reducing income inequality.

Feature Photo: cc/(David Cabrera)