A definition of economic distortion goes: an action (of the government) or situation which leads to non-optimal decisions, or that provides biased information to agents that allocate resources.
Taxes (whether negative or positive) are common economic distortions. Negative taxes are levied in Mexico on fuel. However gasoline prices around the world are rising, as a direct result of high oil prices, gasoline in Mexico is considerably cheaper than in the U.S., almost half as cheap.
Several distortions arise as a result, the worst is that the relative price for emissions of CO2 decrease, a growing environmental concern. People drive more since the relative price of driving decreases, thus, the demand for motor vehicles remains constant at best, instead of the expected decrease. There are no incentives for people to buy smaller cars, or for industries to look for alternative energies. Yet another distortion is that the government fails in one of its chief purposes: poverty and inequality of income distribution reduction.
The ministry of finance informed in an official study that 42.9 percent of the gasoline is consumed by the upper income decil. This means that a negative tax in gasoline is recieved by the wealthiest subset of population. Moreover, official projections point that by the end of 2008 this negative tax will add up to 200 thousand millions of pesos (some USD 20 billion), this is more than four fold the yearly federal budget of regional public Universities.
So, where is the rationale of this negative tax? The central bank remains quiet, clearly, because the negative tax contains not only government prices, but also overall inflation, gasoline taxes affect an important number of prices in the economy, this is, relative prices move with gasoline prices. A faster pace of gasoline price increases is to be implemented. But this is not enough to correct all relative prices that are distorted as a result of low gas prices. Take for example the relative price of exports to foreign imports, commonly know as the terms of trade. Since mexican government supplies all gasoline demanded, more than 45 percent is imported implying that any appreciation of mexican peso will be offset by the increasing demand of fuel.
A welfare asessment such as Kehoe and Serra Puche (1991), concludes that wealth from rural population is transferred to urban population. How can the government asses whether the gains on welfare provided by a stronger peso are not enough to compensate the loss of wealth (even the implicit one of the regressive nature of the negative tax) from high energy prices?