MEXICO CITY - Mexican President Felipe Calderon asked Congress on Tuesday to raise taxes and slash spending on government bureaucracy to prop up public finances as the country languishes in a deep recession.

In an audacious bid to boost revenues, Calderon proposed a new 2 percent levy on all sales without any exceptions, a measure that could draw fire from lawmakers opposed to taxes on currently-exempt food and medicine.

He also proposed to temporarily increase the maximum income tax to 30 percent from 28 percent at present.

A plunge in oil production and the most severe economic contraction since 1932 have slammed Mexico's government coffers, hurting the country's efforts to improve its shoddy schools, roads and hospitals.

We cannot close our eyes to these limitations, Finance Minister Agustin Carstens told a news conference on Tuesday after turning the proposal over to lawmakers.

Mexico is at a crossroads, he said.

Mexico's central bank has warned about raising taxes during hard economic times, but Mexico is also trying to fend off threatened downgrades by major debt rating agencies.

Rating agencies worry about Mexico's paltry tax collection and its dependence on oil, which are used to fund the budget and pay back creditors. A downgrade in the country's debt rating would lead many investors to dump Mexican assets, pushing up interest rates in Mexico and further complicating economic recovery.

Calderon also proposed saving money by eliminating three minor federal ministries and freezing bureaucrats' salaries. Austerity measures and new tax revenues would be worth 180 billion pesos ($13.5 billion) in next year's budget, Calderon said.

The government would also cut the 2010 budget deficit to 60 billion pesos ($4.5 billion), which would be equivalent to around 0.5 percent of Mexico's current gross domestic product. Mexico is seen running a deficit close to 2 percent of GDP this year.

It's a drastic adjustment, Calderon told reporters.

SOCIAL SPENDING

Calderon promised to direct revenues from new taxes to social spending, pledging a major boost for poverty programs.

We can't eradicate extreme poverty or guarantee access for all Mexicans to health care and quality education if we do not have solid public finances, he told reporters.

The new tax on sales aims to collect 70 billion pesos ($5 billion) in 2010.

The proposal would raise the income tax rate next year and hike taxes on cash deposits in banks and on tobacco, alcohol and gambling.
Mexico, which has long had one of Latin America's lowest tax collection rates, has been under pressure to raise non-oil revenues for years. The government takes in taxes worth about 10 percent of GDP -- a level roughly on par with Haiti.

Mexico is a top supplier of oil to the United States but its crude output has slid by more than a quarter since 2004 as yields have dropped at the aging Cantarell field.

Carstens said the government sees Mexico's 2010 oil output slipping to 2.5 million barrels per day (bpd), compared to an average of 2.619 million bpd for the first seven months of 2009.

Oil has begun to run out and the economic crisis has affected government income, Calderon said on Tuesday.

The finance ministry said Mexico's economy is set to shrink 6.8 percent in 2009, its biggest contraction since the Great Depression, but could partially recover next year and expand by 3 percent.

Oil revenues fund nearly 40 percent of the federal budget and bond rating agencies have warned they may downgrade Mexico's debt ratings due to the country's heavy reliance on the waning oil industry.

Lawmakers have until November 15 to approve a budget for 2010, including the president's tax proposals if they are to come into effect next year.

Pledging to push for deep reforms, Calderon also proposed an outline for changes to stifling labor and energy laws, as well as improvements in financial regulation and competition in the telecommunications sector.

It is time to change and to change deeply, he said.

($1=13.3382 pesos)

(Additional reporting by Jason Lange, Luis Rojas Mena and Miguel Angel Gutierrez; Editnig by Kim Coghill)

Mexico