Mexico's Congress approved a landmark tax overhaul on Friday, handing President Felipe Calderon a major legislative victory and Mexico its biggest economic reform in a decade.

Senators backed the package in a vote that capped months of talks over how to boost government revenue so the country can spend more on sagging schools and roads without relying so heavily on oil revenues.

Mexico, a major crude producer with close trade links to the United States, is arguably Latin America's most developed economy but it has one of the lowest tax takes in the region.

The tax law might open the way for changes to allow more exploitation of Mexico's potentially vast oil reserves.

A conservative, Calderon won last year's presidential election only by a hair's breadth. Leftist demonstrators paralyzed central Mexico City for weeks last year to claim vote fraud but a court threw out those accusations.

Now Calderon has pushed two economic reforms through Congress, more than predecessor Vicente Fox managed in six years.

Analysts say the importance of the latest reform is as much political as financial.

"This puts an end to the Mexico that looked paralyzed and incompetent under Fox, and of course Calderon comes out looking good," said political scientist Jose Antonio Crespo.

NO LAME DUCK

Predictions that Calderon, an uncharismatic former energy minister, would have a lame duck presidency hounded by leftists have proven wrong.

He won a pension reform in March and received plaudits in Mexico for taking a tough stance against U.S. President George W. Bush over Washington's crackdown on illegal immigration.

In months of tough negotiations, the president convinced the second-biggest opposition party, the Institutional Revolutionary Party, to back the tax overhaul. Calderon's National Action Party lacks a majority in Congress.

The tax changes, set to generate additional income of more than $10 billion in the first year, are the most important economic reform in Mexico since the government privatized its pension system for nonpublic sector workers in 1997.

Mexico will now increase tax revenues by up to 2.5 percentage points of gross domestic product a year, lawmakers say.

The cornerstone of the plan is a minimum income tax rate for companies at 16.5 percent in 2008, rising to 17.5 percent by 2010.

Mexican stocks, bonds and the peso weakened on Friday as the progress of the tax overhaul was overshadowed by economic concerns in the United States, Mexico's main trading partner. But investors cheered the vote.

"For Mexico this is certainly long term bullish," said Claudia Calich, who manages about $900 million in emerging market assets, including Mexican bonds, for Investco in New York.

Mexico wants to reduce its dependence on revenues from oil exports, which are faltering as yields slip at the country's biggest offshore oil field. Crude revenues currently fund about one-third of the federal budget.

In July, Standard and Poor's credit rating agency boosted its outlook for Mexico's debt to "positive", citing growing prospects for fiscal reform. S&P said on Thursday it wants to take a closer look at the numbers before deciding if the reform is big enough to warrant an upgrade for Mexico.

The reform also would ease state oil company Pemex's tax obligations, and go after tax evaders like street vendors with a levy on large cash bank deposits.

Another measure would slap a new tax on big stock sales, reversing a policy that has kept the tax man away from multibillion dollar transactions on the stock exchange.

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