23 Mexico

Teresa Ter-Minassian
Published Date:
September 1997
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Juan Amieva-Huerta

Mexico has a complex system of intergovernmental fiscal relations, characterized by a relatively high degree of expenditure centralization and by limited revenue-raising powers of state and municipal governments. In 1994, more than 75 percent of general government expenditures were controlled by the federal government, while own revenues of states and municipalities accounted for only 13 percent of general government revenue. The only sources of own revenues of lower levels of government are basically property taxes, fees, and user charges. All other taxes are assigned to the federal government. Local governments are, therefore, heavily dependent on federal revenue sharing. The federal government also relies on specific purpose grants to promote and finance the provision of certain services by lower levels of government. Specific purpose grants have also been used for horizontal fiscal equalization among states.

Overview of Intergovernmental Relations

Against a historical background of high centralization, attempts have been made since the mid-1980s to decentralize some of the federal responsibilities, especially for education and health care services. Since decentralization is not yet fully operative, particularly in health care services, the federal government continues to bear those expenditure responsibilities that have not been effectively transferred to the state governments. This ongoing decentralization process in Mexico could have significant implications for fiscal management and macroeconomic stability. A fuller decentralization would require reforms of the government structure and a substantial strengthening of public financial management, especially at the state and municipal levels.

Government Structure

Since independence in 1821, Mexico has embraced a federal system, established in the Constitutions of 1842, 1857, and 1917, the last of which remains in effect. Constitutionally, Mexico is a democratic, representative, federal territorial structure, consisting of free and sovereign states, but united under a federation. Mexico has a Federal District, 31 states, and 2,392 municipal governments.1 Each state has its own Constitution, which is subordinate to the federal Constitution. Within each state, each municipality is a separate legal entity, but has limited taxing powers. The federal government is divided into autonomous executive, legislative, and judicial branches; this machinery is duplicated at the state level, that is, each state has the same three branches. As municipalities lack a legislative organ and cannot enact laws, municipal laws are established by the state congresses. Municipalities in Mexico have an autonomous executive branch.

The Constitution specifies that the states will share in the revenue from specific taxes and that the share will be determined by the federal government. State governments are required to transfer a portion of shared revenues to municipalities on a monthly basis. The federal Congress has the power, inter alia, to establish the bases upon which the executive branch may arrange loans and take responsibility for public debt.

The bulk of government spending and hence decisions on its allocation, are carried out by the federal government (Table 1). The social security system, external relations, and defense are under the exclusive jurisdiction of the federal government. Other activities are carried out in cooperation with state and municipal governments. These include education, health care services, and other government services (public safety, transportation, and administration).

Table 1.Mexico: Federal and Local Government Expenditure and Taxes
Federal government taxesFederal government expenditures
Corporate income taxFederal administration
Personal income taxService of domestic and foreign debt
Tax on assets of enterprisesDefense
Value-added tax (VAT)Post and telecommunications
Duty on oil extraction (royalties)External affairs
Oil export taxIrrigation
Tax on production and services (excises)Foreign trade
Tax on new cars1Railways, highways, airways, and shipping
Tax on the ownership or use of vehiclesFederal and border police
Real estate transfer tax2
Import duties
Shared taxesShared expenditures
Income taxesHealth
Value-added taxEducation
ExcisesSpecific purpose grant program
Oil export duties3Solidaridad
Import duties Tax on the ownership or use of vehiclesSingle development agreements, (Convenios

Unicos de Desarrollo)
Tax on new carsSpecial police
National parks
State government taxesState government expenditures
State payroll taxState administration
Real estate transfer taxState infrastructures
Tax on motor vehicles older than 10 yearsState public order and safety
Tax on the use of landSanitation and water supply
Education taxService of domestic debt
Indirect taxes on industry and commercePublic libraries
Fees and licenses for some public services
Municipal government taxesMunicipal government expenditures
Local property taxLocal administration
Real estate transfer taxLocal public order and safety
Water feesLocal transportation
Other local fees and licensesLocal infrastructure including water supply and sanitation
Indirect taxes on agriculture, industry, and commerce
Local transit
Residential developmentWaste disposal and street lighting Slaughterhouses, cemeteries, and parks
Source: Information provided by the Mexican authorities.

This tax was suspended for one year on January 1, 1996.

This tax was abolished on January 1, 1996.

Some federal government tax revenues (oil production and export of hydrocarbons) are not included in the computation of the revenue-sharing fund.

Source: Information provided by the Mexican authorities.

This tax was suspended for one year on January 1, 1996.

This tax was abolished on January 1, 1996.

Some federal government tax revenues (oil production and export of hydrocarbons) are not included in the computation of the revenue-sharing fund.

Current Intergovernmental Fiscal Arrangements

The current government system in Mexico is highly centralized, compared with many developing countries, as well as with other member countries of the Organization for Economic Cooperation and Development (OECD). In 1994, only about 3 percent of the general government tax revenue and nearly 34 percent of total nontax revenue were collected by state and municipal governments (Table 2). By comparison, in the United States, these ratios amounted to 18 percent and 53 percent (1993), while in Canada, they accounted for about 43 percent and 57 percent (1992), respectively (International Monetary Fund, 1995). As explained below, state and municipal governments in Mexico rely on transfers from the federal government, mainly through revenue-sharing arrangements. In 1994, these transfers financed more than half of the states’ expenditures and about half of those of municipalities. The relative weight of local government expenditures is somewhat greater than that of taxes. In 1994, about 23 percent of the general government outlays were carried out by state and municipal governments.

Table 2.Mexico: Structure of General Government, 19941
Federal GovernmentState GovernmentsMunicipal GovernmentsGeneral Government
(In millions of new pesos)
Total revenue215,30153,79314,761283,855
Nontax revenue254,98424,8273,06082,871
Net revenue sharing26,9383,44835,386
Total expenditure221,20249,95516,233287,390
Deferred outlays4,9825054895,976
Budgetary balance−5,9013,838−1,472−3,535
Change in third-party account−4,0275,8472922,112
Overall balance−9,927−2,009−1,764−13,700
Financing (net)9,9272,0091,76413,700
(In percent of GDP)
Total revenue16.
Nontax revenue24.
Net revenue sharing2.10.72.8
Total expenditure17.
Deferred outlays0.40.5
Budgetary balance0.5−0.3−0.1−0.3
Change in third-party account−
Overall balance0.8−0.2−0.1−1.1
Financing (net)−
Sources: Secretariat of Finance and Public Credit (Hacienda); and Instituto Nacional de Esradística, Geografía e Informática (1996c).

Excludes operations of the social security funds.

Includes hydrocarbon royalties.

Sources: Secretariat of Finance and Public Credit (Hacienda); and Instituto Nacional de Esradística, Geografía e Informática (1996c).

Excludes operations of the social security funds.

Includes hydrocarbon royalties.

Revenue Assignment

According to the Constitution, the federal Congress is empowered to levy the taxes necessary to cover federal expenditures. The Congress has powers to levy taxes on public utilities, credit institutions, insurance companies, the use and exploitation of the nation’s natural resources, foreign trade, electricity, gasoline, other oil products, and special taxes (see Table 1). Shared taxes with local governments include income taxes, the value-added tax (VAT), excises, oil export and import duties, and the tax on the ownership or use of vehicles.

The fundamental taxation principles—legality, equality, and revenue assignment—are also enshrined in the Constitution. Taxes may be enacted only by the Congress. Taxation must be based on ability to pay—all taxpayers in similar circumstances must be treated equally. Most taxes must be channeled into the federal budget and used for general public expenditures, not earmarked. Some earmarking, however, is allowed, notably for social security contributions. In April 1983, Mexico enacted a federal tax code, which covers tax administration, control, penalties, and procedures.

The most important tax revenue sources for the states are the real estate transfer tax,2 the tax on older motor vehicles,3 a state payroll tax,4 and some indirect taxes on industry and commerce. In addition to these taxes, states can also charge fees for some public services (shows, entertainment, and urban public transportation). As noted above, the state legislatures, in turn, establish the percentage of revenue assigned to the municipalities. States are allowed to keep the proceeds of the federal tax on the use of vehicles, which in 1994 amounted to 9 percent of their basic revenue-sharing entitlement. States are also allowed to appropriate 100 percent of the additional VAT collected from joint—federal and state—audits on VAT payers in their jurisdictions. This has created an incentive to audit by state authorities, although, as noted below, the results have not been substantial so far. The most important source of own revenue for the states is the state payroll tax; in 1994, it accounted for 74 percent of the states’ total tax revenue, followed by the real estate transfer tax at 10 percent. In 1994, own tax and nontax revenue of the states accounted for only 11 percent of total general government revenue. In the same year, tax revenue of state governments amounted to only about 3.8 percent of their total revenue. Net revenue sharing amounted to about 50 percent of state revenues or 2.1 percent of GDP (see Table 2).

Certain tax revenue is reserved for municipalities, namely, those from the property tax, the real estate transfer tax (partially), and some indirect taxes on agriculture, industry, and commerce, which have very low yields; and duties and legal fees on public services rendered by municipalities. Tax and nontax revenues play a larger role at the municipal than at the state level (excluding hydrocarbon royalties). In 1994, municipal governments collected about 52 percent of their own revenue—excluding revenue sharing—from tax sources.

The most important tax revenue source for the municipalities is the property tax, which accounted for about 29 percent of municipal own revenue in 1994. This share is low compared with other OECD countries. In the United States and Canada, for example, over 50 percent and 61 percent of total local revenue, respectively, is from property taxes (see International Monetary Fund, 1995).

The property tax in Mexico is an ad valorem tax applied to the cadastral value of land or building. The rates are determined by each state and are relatively low by international standard; for example, in the Federal District, the rate ranges between 0.026 percent and 0.483 percent (Departamento del Distrito Federal, 1996). By comparison, in the United States, in 1993, the average effective tax rate in the entire country was 1.67 percent; in Massachusetts, it was 3.5 percent, while in Louisiana it was 0.61 percent, which is lower than the highest rate in Mexico’s Federal District.5 Actual collections from this tax are, in general, low because some municipalities, particularly the economically weakest, have neither an official register of the quantity, value, and ownership of properties in their territory nor efficient tax administration procedures. In others, the valuation of the properties for tax purposes remains well below their market value. Property values in the cadastre are indexed for inflation in most states. Some municipalities give property tax and water fees relief to certain categories of pensioners.

Given the low level of property tax collection, a comprehensive review of existing cadastral value is necessary to restore the tax base. The revenue potential of this tax could also be enhanced by raising tax rates,6 eliminating deductions, strengthening its administration, and training local tax officials. Valuation rules on the cadastre and exemptions related to local tax bases could be made uniform throughout the states (as in Canada), to eliminate regional inequities and distortions. Again, this would require coordination among the states on the definition of the tax base. The effective administration of a property tax requires a reliable land cadastre, which may take years to prepare, but the cost of this process will be recouped quickly, provided the property values are updated regularly, in line with market trends.

On balance, there appears to be a need to strengthen revenue-raising capabilities at the state and municipal levels. Local governments could try to develop other more reliable and easier-to-collect tax sources, for example, selective consumption taxes, such as surcharges on utilities including household consumption of gas, electricity, water, and telephone services.7 Moreover, the experience of other countries suggests that Mexican municipalities could also levy cost recovery charges, such as tolls for use of local roads and other user charges. More substantial presumptive taxes on itinerant fairs and markets, or a business license tax based on presumed or actual turnover, could also be considered.

Revenue Sharing

Federal revenue sharing has changed considerably since 1980, with a clear trend toward equalization. For example, total revenue sharing as a proportion of GDP increased from 2.3 percent in 1980 to 3.3 percent in 1994. Similarly, shared revenues increased from about 16 percent of federal government revenue during the mid-1980s to around 19 percent in 1994 (see Table 3). This is the result of continuous revisions to the revenue-sharing formula—particularly since 1990—aimed at increasing the proportion of revenue allocated to state governments. These revisions have raised the weight of shared revenues in total revenues of the states from an average of 45 percent in 1978 to nearly 50 percent in 1994. States receive the bulk of these revenues from the general revenue-sharing fund (Fondo General de Participaciones (GRSF) and the municipal development fund (Fondo de Fomento Municipal (MDF)). The GRSF encompasses about 18.51 percent of the federal revenue eligible for revenue sharing;8 of this, 45.17 percent is distributed in direct proportion to the population of each state every fiscal year. This implies a redistribution in favor of the states with lower per capita collections. An additional 45.17 percent is distributed according to a revenue-sharing coefficient that reflects the taxable capacity of a state as well as its revenue-raising efforts.9 The remaining 9.66 percent is allocated to the states in inverse proportion to revenue sharing per capita in each entity (equalization component).10 The Ministry of Finance calculates each month the amount to be distributed to the state governments. A similar procedure is used for the MDF.

Table 3.Mexico: Revenue Sharing
In Percent of GDPIn Percent of Federal Government Revenue
Source: Secretariat of Finance and Public Credit (Hacienda).


Source: Secretariat of Finance and Public Credit (Hacienda).


Municipal governments obtain revenue-sharing funds from the federal government through three sources. The first source applies to all municipal governments: a 1 percent share of eligible federal revenue through the MDF, 56 percent of which is distributed according to a formula based on the revenue-sharing coefficient of each state government. The formula reflects municipal efforts to collect the property tax and the water fees;11 therefore, the greater the effort the higher the federal revenue distributed to the municipality. The remaining 44 percent is distributed according to a restructuring program for urban commercial areas. States are obliged to transfer these funds to municipalities.

The second source is for municipalities that are involved in the extraction, sale, and export of oil. The municipalities receive 3.17 percent of the duty on oil extraction collected by the federal government (excluding the extraordinary duty). These funds compensate municipalities for environmental damage caused by extraction and sale of oil.

Until 1996, there was a third source for municipalities involved in international trade. They received 0.136 percent of total eligible federal revenues. This mechanism was intended to provide an incentive to control smuggling and control Mexico’s fiscal borders, but was discontinued in 1996.

Tax Administration

The Undersecretariat of Revenue in the Ministry of Finance (“Hacienda”) is responsible for tax policy and tax administration. International trade taxes are administered by the General Customs Administration, a directorate of the Undersecretariat of Revenue. Among the latter’s other functions is intergovernmental fiscal coordination. The National System of Fiscal Coordination is responsible for coordinating the federal tax system with the state and municipal tax systems, and for determining the corresponding share of federal revenue.

In Mexico, federal government revenue is collected by the Undersecretariat of Revenue through the banking system. Revenue collected by the latter is remitted to the federal government (Treasury) for subsequent sharing with the states according to the formulas discussed above.12 The states and municipalities’ own revenues are collected by their respective tax offices. Collection costs and efficiency vary substantially from state to state (the richest states have modern computerized systems and better trained personnel), but this reflects more administrative and institutional factors than the tax structure.

The Undersecretariat of Revenue is organized by functions and in two levels. At the first level there are, inter alia, four general directorates that carry out the main operational functions of tax administration, namely collection, auditing, legal affairs, and customs administration. At the second level of the organization are eight regional tax offices in charge of overseeing the implementation in their territory of the four major tax administration functions noted above. The four aforementioned general directorates provide specific guidelines to the eight regional offices as described below. These eight offices supervise the operations of 65 (previously 261) local tax offices (administraciones locales), which are responsible for administering the major federal taxes throughout the country and the local custom offices (aduanas) located along the border, and at ports and international airports.13 At the state level, there are 32 state tax offices (entidades federativas) responsible for administering state taxes.14

The Directorate for collection determines policies, systems, and procedures for tax collection and enforcement, including control of delinquent taxpayers, recovery of arrears, and application of penalties and sanctions. It formulates computer policies and programs, and administers and updates the national taxpayer register. It also designs the revenue collection systems to be used by local and state tax offices. This Directorate works jointly with a special unit (Unidad de Coordinación con Entidades Federativas), which is responsible for coordinating all tax administration functions with state tax offices.

The Directorate for audit administration formulates the annual audit plan and provides the local tax offices with guidelines on policies and programs for audit, inspection, verification, and compliance with federal tax obligations (including customs). While federal tax audits are the main responsibility of federal auditors, state auditors only participate in VAT audits.

The Directorate for legal affairs regulates collection enforcement and other tax matters involving litigation. It also provides guidelines and assistance to the legal departments of the 65 local tax offices in the exercise of their duties.

The General Customs Administration regulates international trade taxes, free economic zones, cross-border trade, and temporary import exemptions, and also regulates import quotas. It is responsible for customs clearance and for policies dealing with customs agents and representatives.

To modernize the tax administration and improve its effectiveness, in December 1995, the Mexican Government enacted a law creating the Tax Administration Service (Servicio de Administración Tributaria (SAT)), a semiautonomous entity that will operate under the guidance and supervision of a revenue board (presided by the Minister of Finance). The Undersecretariat for Revenue will continue to be in charge of tax policy functions, with advice from the SAT. The latter is scheduled to become operational on July 1, 1997 (see Secretaría de Hacienda y Crédito Público, 1996).

This new agency will have the authority to collect all federal taxes and will carry out all tax administration functions, including auditing and taxpayer assistance. It will also incorporate customs administration as well as the federal tax police.

Expenditure Assignment

According to the National Institute of Statistics (Instituto Nacional de Estadística, Geografía e Informática, 1994a), in 1993, Mexico’s public sector GDP amounted to about 16 percent of total GDP, down from nearly 22 percent in 1987 (Table 4). In the same year, 54 percent of public sector GDP was accounted for by the general government. Of this total, 22 percentage points corresponded to the federal government, 10 percentage points to the social security institutions, and the rest to local governments (state and municipal governments). This implies that the size of local governments in Mexico’s economy is relatively small. State enterprises generated about 46 percent of public sector GDP, down from 69 percent in 1990. The relative importance of public enterprises began to decline after 1989—particularly in 1992 and 1993 as a result of privatization15 (see also Figure 1).

Table 4.Mexico: Public Sector GDP
Public sector20.621.718.818.420.
General government6.
Federal government4.
Local governments11.
Social security1.
Public enterprises14.015.513.012.513.910.48.47.3
Private sector79.478.381.281.679.882.884.084.3
Source: Instituto Nacional de Estadística, Geografía e Informática (1994b).

Includes state and municipal governments.

Source: Instituto Nacional de Estadística, Geografía e Informática (1994b).

Includes state and municipal governments.

Figure 1.Mexico: Public Sector GDP

(In percent of GDP)

The public sector workforce remained fairly stable from 1986 to 1989 (Figure 2), at 4.3 million remunerated positions or about 15 percent of the labor force. From 1989 to 1993, the overall public workforce declined by about 6 percent because of the impact of privatization of public companies, partly offset by an 8 percent increase in the size of the civil service. The composition of the latter was substantially affected by the decentralization process (see Table 5). In 1993, decentralization in the education sector transferred the administrative apparatus—including personnel—from the federal to state governments. Accordingly, the share of workers employed by the federal government in total general government employment decreased from 71 percent in 1992 to 41 percent in 1993. In the same year, state and local governments accounted for 49 percent of the total and the social security institutions for 10 percent.

Table 5.Mexico: Workforce Employed by the Public Sector(In thousands of workers)
Public sector4,3454,3774,3644,3084,2734,2784,0714,049
General government3,3173,3463,3483,3583,3913,5183,5413,612
Federal government2,3802,4122,4002,3982,4082,5002,5091,473
Local government16466336326316436616651,768
Social security291301316329340357367371
Public enterprises1,0281,0311,016950883760531437
Source: Instituto Nacional de Esadística, Geografía c Informática (1994b).

Includes state and municipal governments.

Source: Instituto Nacional de Esadística, Geografía c Informática (1994b).

Includes state and municipal governments.

Figure 2.Mexico: Work Force Employed by the Public Sector, 1986–93

(In thousands of workers)

In Mexico, the expenditure functions for different levels of government are not clearly determined in the Constitution. The federal government assigns most expenditure functions. In 1994, federal government expenditures on administration amounted to 8.7 percent of GDP, while capital expenditures and transfers represented 2.4 percent and 5.9 percent of GDP, respectively.16

The bulk of state government expenditure is concentrated on public order and safety, transportation, health, education, and sanitation. In 1994, states’ expenditures on public order, transportation, and administration represented on average about 57 percent of total net state government expenditure (excluding debt amortizations). State expenditure on infrastructure and public works accounted for about 25 percent of total net expenditure. State expenditure on transfers (excluding revenue sharing with municipalities) exceeded 17 percent, reflecting mainly the distribution of subsidies and grants (see Table 2).

As regards municipal government expenditure, in 1994, expenditures on administration, including public order and local transportation, represented about 63 percent of total net spending. Municipal expenditures on infrastructure amounted to 27 percent of total net expenditures, while the remaining 17 percent was allocated to transfers and subsidies to local private and public institutions (Instituto Nacional de Estadística, Geografía e Informática, 1996c). Municipalities spend a larger proportion of their budget on wages and salaries of local employees than state governments. In the economically weakest municipalities, the share of capital outlays in total expenditures is very low. In these municipalities, maintenance for roads and local schools is often carried out by the private sector, mainly through extensive community participation coordinated by the local authorities. Some municipalities have developed infrastructure projects with the assistance of the state or the federation, mainly through the general purpose grant programs described below. Contributions of citizens in the form of work have also been used to match the funding.

In Mexico, the state and municipal governments may spend their revenue-sharing allotments for any purpose. In practice, however, most municipal governments—particularly the economically weakest—use most of their allocations to pay wages to government employees. High administrative expenditure reflects in part inefficiencies in the delivery of goods and services provided by the municipalities.

As discussed above, the federal government has control of major tax sources, as in many countries, particularly in Latin America. This leads to the problems of vertical imbalances because municipal governments’ own tax revenue is only a fraction of municipal expenditures. The same vertical imbalance is present at the state governments’ level, while in recent years federal government tax revenue has been higher than federal government expenditures. Therefore, an imbalance between own revenues and expenditures net of transfers for each aggregate level of government is present. This implies that the federal government faces an imbalance in its favor, and the balance between own revenues and expenditures is redistributed to local governments to correct their imbalances. In most countries, a substantial vertical imbalance also leads to horizontal imbalances. These imbalances are often redressed through a system of general purpose grants, along with specific purpose transfers (see below).

The Decentralization Process

Decentralization can contribute to the more efficient provision of local public services, because local governments are likely to have better information on social needs, especially in education and health care. Accordingly, a number of countries, particularly in Latin America, have moved to decentralize the provision of education and health care to the state governments. The central governments retain responsibility for defining the main lines of education and health care policies.

Over the short to medium term, Mexico is expected to continue decentralizing authority over a number of functions, including education and health care. While this may increase allocative efficiency, it carries significant risks for macromanagement and distributional equity. This is especially the case when lower levels of government have limited revenue-raising and financial management capacities.

In general, a successful decentralization effort requires a major reform of the government structure and a strengthening of public financial management. Decentralization also requires that there be institutional arrangements for intergovernmental coordination, budgeting, planning, and implementation, as well as strong local institutional capacities. Intergovernmental coordination—through regularly scheduled meetings of relevant officials at the different levels of government—is critical to improve public sector management. For decentralized institutions to succeed, there must be effective monitoring and auditing systems for lower level performance. The federal government must provide technical assistance and training on management issues to local officials.

It is too early to assess the outcome of the decentralization process in Mexico. Since decentralization is not yet complete, the federal government continues to bear expenditure responsibilities that have not been effectively transferred to state governments, particularly in the case of health care expenditures. On balance, it appears that education expenditures are distributed equitably (Shah, 1994; Amieva, 1993), but the health sector lacks comprehensive coverage, and service quality is poor (Amieva, 1993).


Based on the principle that educational development should be propelled by the federation, the Public Education Secretariat (SEP) was created in 1921. The concentration of decision-making power in the central government, however, did not prove conducive to the development of education. A beginning toward decentralization in education was made in 1973 with the creation of nine regional units and subunits for administrative services. Deconcentration,17 however, was not initiated until 1976, with the creation of 31 state offices of the SEP. The goals were to involve the states in the educational development process, to increase the efficiency of education, and, more generally, to increase participation by the community in the education process.

From 1976 to 1982, the SEP successfully completed the deconcentration process (Pescador-Osuna, 1993). The process of decentralization resumed in 1982 with the creation of advisory committees. The work of these committees consisted of gathering the necessary information related to basic education and extending teacher training to each state. To consolidate these efforts, the federal government created the public education state councils and transformed the educational service units of the states into general departments of coordinated public education services. However, pressure from the powerful national education workers’ union during the 1980s slowed the transfer of human and financial resources needed to initiate the decentralization process.

The administration of President Salinas (1988–94) announced its intention to modernize the education sector. This process had two elements: the decentralization of education and the strengthening of society’s participation in education. For its implementation, the federation transferred the school institutions in 1993 (basic and postbasic education) to the state governments with all the components being utilized at that point by the Public Education Secretariat (Solís-Cámara, 1993).

The National Agreement on Public Education Modernization (1992) stipulates the sequencing of the decentralization. This agreement formally transferred the administrative apparatus and the schools, their assets, and staff from the federal government to the state administrations. The agreement also redefined the Public Education Secretariat’s normative functions, and the secretariat was restructured accordingly. The General Education Law (1993) redistributed the educational responsibilities between the federal and state governments; however, the SEP’s internal regulations are still being revised to conform with this law.

Mexico is currently consolidating the education decentralization program. The country’s 31 state governments are now responsible for managing the publicly financed basic and postbasic education services, which were previously administered by the federal government. This explains the sharp increase in remunerated positions in the local governments (see Figure 2). The SEP, in turn, is focusing more on policy issues, allocation of nonrecurrent resources to regions or municipalities, and evaluation.

Health Care

Mexico’s public health programs include the social security system and the Secretariat of Health (SSA). In 1993, the Social Security Institute for private sector employees (IMSS) covered 37.5 million beneficiaries, while the Social Security Institute for public sector employees (ISSSTE) covered about 8.5 million.18 Together, the two institutions covered only about half of the total Mexican population. Private sector coverage for that year—excluding IMSS—is estimated at about 4.3 million, or 5 percent of the total population. The uninsured population is the responsibility of the SSA. The SSA is in charge of the main specialized hospitals, finances most of the states’ health services, and runs the National Institutes of Health.

Historically, health service management in Mexico has been over-centralized. Management staff at the federal level are often unaware of local needs or are limited in their ability to act, owing to bureaucratic requirements. Geographic distances and several levels of administration delay the implementation of remedial actions at the local level (Amieva, 1991). Moreover, the SSA’s procedures are inefficient in many respects, and characterized by duplication. As a result, the health care system is not comprehensive in coverage and suffers from poor quality of services. The system remains inordinately centralized, unable to allocate resources efficiently, and excessively bureaucratic.

A plan to decentralize health care was formulated in the early 1980s. During the De la Madrid administration (1982–88), health care was decentralized in 14 of the 32 states; this transferred some, but not all, decision-making power (including planning, budgeting, and personnel) from the federal to the state level. Decentralization, however, came to a halt during the Salinas administration (1988–94). The present (Zedillo) administration intends to complete and deepen decentralization in all states. A program to delegate the tasks of decentralizing management, budgeting, and planning is under way. This decentralization has been slow, because the states’ lack of appropriate managerial and professional skills and information systems has inhibited their effective use of resources. Another obstacle to the decentralization of health care services is the division of responsibility for public health care service between the social security institutes (for public and private sector employees) and the SSA.

Budget Formulation and Implementation

The Constitution does not specify in detail the budget responsibilities of the executive branch. It does state, however, that the executive branch must send to the Congress for approval an annual budget, as well as the tax revenue measures necessary to cover expenditures. The Congress approves (before the beginning of the fiscal year, which coincides with the calendar year) the general outlines of the budget and the details of revenues and loans. The Ministry of Finance prepares quarterly reports to the Congress on the evolution of the main macroeconomic indicators and public finance statistics. Reports are also submitted to the Congress on the execution of the National Development Plan, the evolution of the external and domestic debt, and the general framework of economic policy. The latter document is presented jointly with the budget proposal, and defines the main fiscal policy actions as well as the annual macroeconomic targets.

In Mexico, the Secretariat of Finance and Public Credit is in charge of the federal budget process, and it acts in consultation with the spending departments to establish budget priorities. Mexico’s fiscal year involves three distinct processes: formulation, implementation, and audit.19 In practice, there are some important delays in completing these phases, so that the formulation is not begun on time, audit is late, and the implementation of the current budget lags behind schedule. Local budgets follow the same programming-planning-budgeting process. Some states, however, experience considerable delays in some of these phases, particularly in budget formulation and execution. These delays result in a heavy round of activities from September to December as federal and local authorities rush to allocate funds for the current fiscal year at the same time as formulating the budget for the following year. However, over the years, these delays have been reduced in many states as a result of computerization and administrative reforms.

The lack of multiyear budgets and forward expenditure plans is a shortcoming of the Mexican budgetary system. It may affect adversely private investment, both domestic and foreign, and, more importantly lead to the approval of multiyear investment projects without congressional scrutiny of outlays beyond the first year, thus imparting excessive rigidities to future spending decisions.

In Mexico, the Ministry of Finance holds the main budgetary powers and responsibilities, including revenue, expenditure, and public debt. It defines the framework for fiscal policy and prepares the macroeconomic forecasts. The Central Bank also plays a major role in financial programming. The Secretariat of Finance and Public Credit is responsible for paying the civil service wages, coordinating the expenditure programs, and monitoring the revenue and expenditure flows. Its debt management unit manages the government’s external and internal debt. The Treasury prepares the monthly cash spending plans and executes budgetary payments to other levels of government and to private sector contractors.


In Mexico, information on general and specific purpose grants is scanty and not suited to detailed analysis. In the 1980s, Mexico made use of annual federal matching general purpose grants on current and capital investment programs. The federal government prepared the so called single development agreements (convenios únicos de desarrollo) with each state government.20 With these agreements, fiscal coordination extends to the expenditure budget exercise. At the same time, general agreements are concurrently reached each year on municipal government expenditure policy through the Government Supervision and Evaluation System, which is used to control the programs and resources agreed upon between the federation, states, and municipalities (Baqueiro, 1992).

Under the single development agreements, each municipal government must verify the execution of programs financed through federal grants. Municipal governments are required to provide quarterly spending plans and financial information, as well as any explanation and record that the federal government requests on the programs. Currently, the federal government develops its public investment program in coordination with local governments. The municipal governments must also verify physical and financial progress and report on them to the Secretariat of the Comptroller General. These programs, however, have lost importance in the 1990s and have been virtually replaced by the national solidarity program (Solidaridad).

In addition to funds allocated through the revenue-sharing formula and general purpose grants, this federal government policy instrument, Solidaridad, has gained importance in recent years. It allocates federal resources to municipal governments for specific programs.21 In 1994,Solidaridad comprised 32 programs and its expenditures amounted to about 0.8 percent of GDP. Solidaridad is, in essence, a specific purpose grants program targeted to the poorest regions of the country. It is coordinated by the executive branch (the Ministry of Social Development) and provides discretionary grants to states and municipalities that are used to finance regional projects. These grants are defined in the context of the so-called social development agreements. Introduced in 1989, these agreements constitute an instrument designed by the federation and the states to define priorities and programs of mutual interest; they represent the channel for support of the decentralization of important functions to the states and municipalities. They strengthen the states’ and municipal governments’ capacity to make decisions. Solidaridad sets policies and strategies, and each state selects the social and productive projects and establishes priorities. Thus, in addition to financing community-based development efforts, Solidaridad is also used as a vehicle for combining federal, state, and municipal resources and grants to finance large infrastructure projects.22 This implies that Solidaridad is a mechanism allowing the federal government to work with the states and municipal governments and to influence their spending decisions, thereby improving the overall quality of state and municipal investments.

Solidaridad also entails commitments of municipal government resources. For example, Solidaridad distributed US$2,248 million in 1992 and US$ 2,409 million in 1993. Municipal government resources amounted to 48 percent and 50 percent, respectively, of the total amount invested in Solidaridad’s projects (Secretaría de Desarrollo Social, 1993). In a context of high centralization, these grants have been a significant tool for improving the physical infrastructure of the states and municipalities. Solidaridad grants are also designed in principle to promote horizontal fiscal equalization between states, that is, to reduce differences in income or taxable capacities. Data limitations, however, have so far hindered an analysis of the effectiveness of this program in reducing regional imbalances.

Critics of Solidaridad point to several shortcomings of the program. They note that there is neither a clear set of criteria for distributing these grants nor an effective evaluation of the projects financed. The poverty alleviation component of the program has also been questioned, on the grounds that it is not well targeted to the poorest population groups. Clearly, the proliferation of specific purpose grants may become unwieldy and inefficient. The lack of transparent criteria for the allocation of those grants makes them relatively unpredictable.


Since 1988 most state government deficits have been increasing. Their total deficit reached MexN$0.2 billion or about 0.6 percent of GDP in 1994 (see Table 2), while municipalities have shown small deficits. These deficits have been reflected in the growth of their outstanding debt, which has increased by about 62 percent in real terms since 1988 (Gamboa-Gonzalez, 1996). It would appear that the main factors leading to increased deficits were the expansion of states’ current and capital expenditure and access to domestic financing by the banking system, as noted below. This suggests that the federal government has had difficulty in imposing financial discipline on the states.

States and municipalities do have the authority to issue securities in the domestic capital market, but only the federal government is entitled to borrow abroad. State debt instruments are generally issued through government-owned national development banks (Baqueiro, 1992). This is a fairly recent development, and has been used by the most developed states to finance toll roads and other infrastructure projects. The rate of return offered by these instruments is market determined and there is no subsidy involved. Also, state governments frequently use their revenue-sharing funds to guarantee loans they receive from the banking system.23

States are allowed to borrow domestically, if they have the authorization of their local congress, with most of the states’ loans coming from private banks and about 40 percent from government development banks—for specific infrastructure projects. The use of commercial bank borrowing has probably had an adverse effect on the states’ efforts to increase own revenue and to control expenditure. On December 31, 1995 total state and municipal government debt to commercial and development banks had reached about MexN$29 billion, or about 1.8 percent of GDP—mostly from state governments.24 This growth of the state debt is a cause of concern because, if continued, it may eventually have an adverse impact on the federal budget, if the states become unable to service their debt, particularly in view of the current high level of real interest rates and tight credit conditions. Local governments can also accumulate expenditure arrears with the private sector, which in December 1995 amounted to MexN$3 billion or 0.2 percent of GDP.

Municipalities can also borrow from commercial banks, but rarely do so. In recent years, the Central Bank has not provided loans or funds to municipalities. Municipal governments may contract loans intended to finance productive public investment, including those carried out by their decentralized agencies or public enterprises, in accordance with the principles set forth in state legislation. Municipal governments often use their federal revenue-sharing funds to guarantee the loans they receive. To finance local projects that meet federal government requirements, loans can be obtained from the national development banks—a source of considerable financing. State and municipal governments’ requests to use their revenue-sharing funds to guarantee their loans are recorded in a special register (Baqueiro, 1992). Lower levels of government can also borrow from the higher levels. All state governments and municipalities have such liabilities.

Summary and Conclusions

Since 1980, Mexico has begun various reforms of its intergovernmental fiscal relations. These reforms seek to improve government efficiency and redefine the role of the lower levels of government. A substantial share of state and municipal revenue in Mexico is derived from the revenue-sharing mechanism, federal general purpose grants, and specific purpose grants. Although the redistribution formula has led to some strengthening of the states’ tax collection efforts, the results have been limited to date. In 1990, Mexico introduced modifications to the revenue-sharing arrangements, which have improved them in some respects. Currently, the main criteria for distributing tax sharing are population, fiscal capacity, fiscal effort, and an equalization component. There is a risk that further changes in the revenue-sharing mechanism (for example, increasing the pool of funds shared by the states) may weaken the federal government’s ability to use fiscal policy for macroeconomic management. This calls for caution in revising the arrangements.

The capacity of state and municipal governments to raise revenue remains limited. States’ own resources consist basically of fees and a small number of taxes with low yield. The bulk of municipalities’ revenue is derived from the revenue-sharing mechanism. Local governments also continue to depend largely on federal grants. Municipal governments currently have limited capacity to raise own tax revenue mainly because of inadequate cadastres, low property tax rates, deductions, and inefficient property tax collection procedures. The potential for increasing property tax revenue for the municipalities is, however, considerable. Giving the states and municipalities more taxing powers should be considered. Local governments could also levy selective consumption taxes, such as surcharges on utilities including household consumption of gas, water, electricity, and telephone service. Such taxes are easier to collect and create less distortions. Moreover, as in other countries, municipalities could also levy cost recovery charges, such as tolls for the use of local roads and user charges. Presumptive taxes on itinerant fairs and markets could also be considered.

Even after revenue sharing, a significant vertical fiscal imbalance persists. The federal government has utilized specific purpose grants through the Solidaridad program to reduce this imbalance. Solidaridad grants have also been used to correct horizontal imbalances. Solidaridad funds have become an increasingly important source of funding for state and municipal expenditures. Solidaridad has played a significant role in channeling social expenditure to the poorer and economically weaker states. Indeed, one of its great successes has been its effectiveness in involving the community in local infrastructure projects. It would appear, however, that there is a need to streamline Solidaridad, while continuing to use its other funds for matching grants to states and municipal governments. At a minimum, it should be ensured that Solidaridad programs are consistent with the sector strategies adopted by the main line secretariats. Likewise, the distribution of matching funds to local governments should be made transparent and based on need criteria.

Mexico remains a highly centralized federation. In 1994, more than three quarters of general government expenditures were controlled by the federal government. The share of administrative expenditures in total municipal governments’ spending is rather high, reflecting inefficiencies in the delivery of municipal services.

In recent years, the government has embarked on a decentralization process, particularly in education and health care, aimed at improving the efficiency and quality of public services. While it is difficult to predict the success of such decentralization efforts, the federal government is likely to play a continuing role in coordinating these efforts and in ensuring that the most vulnerable groups receive some minimum level of services. Decentralization offers potential gains in efficiency and improvements in the quality of education and health care. A successful decentralization, however, requires structural reforms in the federal government, as well as an improvement in the collection of performance indicators, the encouragement of community participation, the establishment of additional societal organizations to provide services, and the strengthening of state and local financial management. There are, moreover, significant macroeconomic risks involved. It is vital that decentralization not unduly weaken the federal government’s ability to use fiscal policy for macroeconomic management.

It would appear that the use of state bank borrowing to lessen the states’ liquidity constraints has had an adverse effect on their efforts to increase own revenue and control expenditure. Although the states’ government debt is currently not very large and the federal government has introduced some measures to prevent excessive borrowing, the lack of effective controls over state borrowing could lead to further strain and macroeconomic instability, especially under conditions of tight money and high real interest rates.

One of Mexico’s important fiscal problems has been the lack of coordination of tax policy and administration among levels of government. The lack of uniformity across the states in the kind of taxes levied and their rates, particularly on the property tax, results in an uneven geographic distribution of the fiscal burden. Efforts should be made to improve collection efficiency by strengthening the present tax coordination and harmonization agreements between the federal government and the states. Improving tax collection by local governments would require intensive training and additional funding. Finally, future intergovernmental reforms should include the introduction of multiyear budgets, to help integrate multiyear programs and medium-term macroeconomic objectives.

This paper was written while the author was in the IMF and was presented at the National Tax Association Conference, Boston, November 10, 1996. The author is grateful for helpful comments received from Ehtisham Ahmad, Katherine Baer, G.A. Mackenzie, Carlos Silvani, Teresa Ter-Minassian, and Charles Vehorn, and from the Mexican authorities.

The 1990 population census indicated that there were 649 municipalities that had fewer than 10,000 inhabitants (27 percent of the total) and 324 had fewer than 5,000 inhabitants (14 percent).

The sale of immovable property was subject to a federal tax—the real estate transfer tax—and to a similar tax levied by the states. The tax base was the sale price. The rate of the federal tax was 2 percent, and state tax rates could not be higher than the federal rate. The federal tax was abolished on January 1, 1996.

The states operate a tax on motor vehicles older than ten years, based on the residual value of the vehicle, that is, the purchase price adjusted for inflation and depreciation.

The Federal District and some states levy a tax on payrolls to be withheld by employers. State payroll taxes fluctuate between 0.65 percent in the state of Hidalgo to 4 percent in South Baja California.

Rural land is normally taxed at half of the rate. In most municipalities, these tax rates are grossly inadequate, but the local authorities prefer to avoid the political problems associated with modifying such rates.

In Mexico, the decision to increase property tax rates must be made by state congresses.

Water and electricity charges for households in Mexico are quite low by international standards.

This is defined as total tax revenue plus oil levies (except surtaxes and special taxes). Some federal government tax revenues from oil extraction and exports are not included in the computation of the GRSF amounts.

The GRSF revenue-sharing coefficient is given by


  • IAt1i = assignable taxes collected in state i in year t − 1,

  • TB = ∑Bi = total entitlements,

  • CPt1i = revenue-sharing coefficient for state i in year t − 1, and

  • Bi = entitlement to state i.

The formula, therefore, takes into account: (1) the fiscal effort indicator, which includes assignable taxes collected in state i (taxes on new automobiles, taxes on motor vehicles, and taxes on production and services); and (2) the state’s share in total entitlements of the preceding year. The former is derived by dividing the assignable taxes collected the preceding year by those collected the year before. This formula generates a pie that must be divided so that one state’s loss is another’s gain.

Poorer states, whose per capita entitlements according to the first two shares fall below the average, receive more out of the 9.66 percent of the pool than those whose per capita entitlements lie above the average.

The MDF revenue-sharing coefficient is given by:


  • Ai = revenue sharing to state i,

  • TA = ∑Ai

  • CEt1i = revenue-sharing coefficient for state i in year t − 1, and

  • IPDAt1i = total property tax and water fee collections of state i.

Since 1992, the VAT is administered exclusively by the federal government.

The main taxes administered by local tax offices are the income taxes, the VAT, the excise taxes, and the tax on new automobiles. In some states, local offices also administer the tax on motor vehicles and the real estate transfer tax (see Table 1). Since 1993, several important tax administration reforms have been introduced to simplify the existing system (Gil-Díaz, 1995).

The state tax offices administer the following major taxes: the state payroll tax, the tax on use of land, the real estate transfer tax, the property tax, and the business license.

During 1983–96, the government divested from most areas of economic activity—hotels, sugar mills, telecommunications, airlines, the banking sector, and the steel industries. Of the 1,155 public enterprises in 1982, 960 firms had been divested by May 1996. During 1989–94, about 300 enterprises were privatized, with total proceeds of about MexN$75 billion (US$25 billion). The Mexican privatization plan has been one of the most extensive in the world, with total dollar proceeds surpassed only by New Zealand and the United Kingdom. Privatization was followed by government deregulation in several sectors and the decentralization of education.

In Mexico, state and municipal governments do not provide data on the economic classification of their expenditures.

Deconcentration is a limited form of decentralization, that is, the delegation of executive power from federal to regional agencies. Decentralization means empowering regional agencies to make their own decisions rather than following those made by a regulatory agency.

In addition, there are special social security institutes for employees of some state governments, PEMEX (the petroleum company), and the social security institute of the armed forces. In 1990, these institutions together covered 1.25 million people, or about 1.5 percent of the total population.

For example, as the 1995 budget went into effect, the audit of 1994 began, with the report due on June 15, 1995; the formulation of the 1997 budget usually begins in April 1996, to be completed for presentation to Congress by November 15, 1996.

These agreements must follow the guidelines of the National Development Plan.

Solidaridad embodies several individual programs: municipal funds, neighborhood urban development programs, water supply and sanitation, rural roads, income-generating projects, agricultural production loans, health, solid waste management, employment training, rural electrification, and special regional development programs.

These works often involve grater participation of responsible federal line agencies and a national development bank (BANOBRAS), which provides additional financing to the investment programs.

These loans have relatively long maturities (less than seven years).

Local government debt is concentrated in the richest states, which have the largest tax bases. The federal government has introduced some measures recently to prevent excessive borrowing. Furthermore, these states have started to restructure certain debt to both commercial and development banks. The restructuring of states’ debts, however, should be accompanied by a decisive adjustment of their finances.


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