Mexico's New Tax System

							Introduction:




Because of all the fiscal leakage from the huge informal economy -not to mention
an upper class with clever accountants- tax evasion ranks among Mexico's
favourite pastimes.




Mexico is Latin America's second-largest economy, but currently it has one of the
region's lowest tax-collection rates: Mexico collects taxes worth only 11.2 percent of
its gross domestic product. Countries such as Brazil and Chile collect more than 15
percent, and the United States takes even more. Over the last seven years, oil has
accounted for between a fifth and a third of public income. Last year, the Finance
Ministry had to cut spending several times to make up for falling oil prices.


Mexico’s economics analysts reckoned that, effectively collected, taxes could, in a
healthy way, boost government income and ease dependence on oil exports.




President Vicente Fox sent to the congress a new tax law “initiative” that proposed
to raise nearly 10 percent of total revenue, by means of applying a Value Added
Tax (or IVA, according to its Spanish acronym) rate of 15% to the sales of food,
medicine and press publications; all of which were currently tax-exempted.


The reasoning of President Fox’s government departs from the position that the
fiscal reform will bring, as a consequence, a firmer control in the short term over
inflation, in spite of the increase of the IVA; diminutions of credit interest rates, and
will reactivate the country’s economy to guarantee a maintained average growth of
an annual 7%, with a consequent constant increase in employment and job
creation levels, guaranteeing to increase the standard of living of the population.
That sparked outrage among millions of average Mexicans, knocking down Fox's
approval rating to about 50 percent from a high of 80 percent, according to
independent surveys. Legislators said that the Fox plan would have punished the
country's poor, who make up about 40 million of the country's total population of
100 million.




The New Taxes and some of the Affected Stakeholders…




Instead of looking for alternate, more conciliatory, measures to collect the needed
resources; lawmakers approved, in a lightning, last minute session, a new tax code
that is expected to add about 60 billion pesos to the finance ministry's coffers, half
of what the government initially sought to collect in additional revenue when it
submitted seven initiatives to revamp Mexico's tax laws in April.




The new tax code pretends to increase the government’s budget by imposing the
following additional taxes –just to name the most insidious- :


• A 10 percent tax on soft drinks that would apply mainly to drinks made with high
fructose corn syrup.


• A production tax on cigarettes will be raised to 50 percent from 21 percent, with
further increases expected to bring the rate by 2004 to 110 percent.


• A 10 percent tax on telephone services


• Liquor taxes ranging from 25 percent to 60 percent based on alcohol content.


• A 3 percent “Wage Credit Substitutive Tax” on payrolls.
• Taxes of 20 percent on “luxury” goods.




Such taxes were described as “undesirable and designed by political groups,
instead of economists; groups that decide who will benefit and who will loose” by
the1992 Nobel Prize winner for Economics [Becker 2002].




Worker Unions:


‘It is not possible for us to accept such an unfair fiscal system that punishes those
workers with less income …” –Unión Nacional de Trabajadores [UNT 2002]




In my opinion workers’ income will be “punished” indeed: some of their benefits will
be taxed and they will have to pay more for goods and services. Even those goods
and services not affected by the IVA increment will suffer a price increase due to
the rise in prices of some of the “so called” luxury goods (I.E. working boots),


public and freight transportation, etc.


Some benefits, formerly exempted under other governments as a means to let
workers enjoy a higher income without going over taxable limits –product of years
of union “struggles”-, will be taxed thanks to the new income tabulations that benefit
only the highest-paid 10 percent of workers.




Construction Industry:


Forced by the new taxes, the construction industry will have to buy and utilize more
machinery to replace human labour, incurring into further expenses and debt, and
laying off workers.


‘The Fiscal Reform cannot be qualified as sufficient or insufficient, but as inefficient;
overburdening the middle-class economic sector…’, noted Jorge Cáceres Zetina
[Cáceres 2002], president of the Mexican Chamber of Construction Industry, and it
was pointed, at the end of one of their weekly meetings, that the construction
industry would have to look for new construction processes where less direct labor
were utilized, since the wage credit, once subsidized and paid by the government
to help promote job creation, will be levied as a new tax.




Telephone Companies:


Telecommunications industry officials argue that the new tax bill will force
companies to halt investment plans in the country's telecommunications
infrastructure, generating job losses and slowing Mexico's move into digital
communications.


A 15 percent value added tax (IVA) is already levied on telephone services in
Mexico and the new code will add another 10 percent. In other words a 25 percent
tax applies to most local and domestic long-distance services, although it excludes
international calls, calls from rural areas, basic Internet access and interconnection
fees.




Assembly Industry:


‘The maquiladora industry businessmen demand fiscal rules to be clear and
permanent; something that México has not provided; if Mexico cannot offer clear
and permanent rules many investors will choose to leave for another country,
specially to Asia and Central America…’ John Christman, Ciemex-Wefa consultant
[Christman 2002].
The reform approved last year had a negative impact on the maquiladora industry:




The question of Permanent Establishment was not solved. The Permanent
Establishment Regime addresses the nature of the taxes that must be paid in
Mexico by U.S. based maquilas that also pay taxes in the United States; the status
of the rules concerning the application of this regime will remain undefined until
2004, creating an environment of uncertainty; negatively affecting the growth of the
already established companies and driving away new investors, who may well give
a second thought to the possibility of opening new assembly plants in Mexico.




During last year the maquilas sector in México lost over 300 thousand jobs, due to
the deceleration of the U.S. economy, and is expected to loose many more thanks
to the application of a new tax that will charge employers 3% of the net worth of
payrolls.




Restaurants and Bars:


Owners and managers fear that many of their regular customers will head for street
stands; since they are not licensed by “Hacienda” (Mexican IRS) because they
belong to the informal economy, street stands don’t pay -nor charge- any kind of
taxes. But restaurants that serve anything stronger than wine now must tax
customers at 20 percent -even if they drink only water- or have the customer sign a
special tax form, under penalty of perjury, and present tax identity documents
before leaving the restaurant. As many owners pointed the new fiscal measures
will only decrease consumption of certain products and increase illicit activities
such as liquor smuggling [Garduño 2002].
I find that the prepared food industry, wounded already by the Mexican economy,
will face one or their worse crisis: liquor can be taxed up to 60 percent (depending
on its alcohol content) and to dine out is considered a luxurious activity charged
with a tax of 20 percent; as a result, suddenly, habitual costumers of restaurants
and bars can be charged up to 80 percent of their total consumption.




Beverage Companies:


Bottlers that make syrups for soft drink dispensers will have to pay a 20 percent
production tax if they use corn sweeteners. The 10 percent tax on soft drinks would
apply mainly to drinks made with high fructose corn syrup, a sweetener imported
from the United States and which competes with Mexico's struggling sugar industry.
Only drinks made with sugar cane would be exempt from the new tax.




The tax on using corn sweeteners may encourage beverage producers to use
Mexican-grown sugar cane as their main raw material. I (we) know that sugar cane,
besides being subsidized, is more expensive than higher fructose, so even if
bottlers decide not to use corn sweeteners to avoid paying more taxes; they will
find their operating margins reduced anyway when they spend more on sugar
cane.


The Mexican Stock market’s reaction:




As we can see, from the information below, the approval of the new tax code is


reflected by negative flows in the stock exchange (let us note that the overall


behaviour of the stock market reflected a loss of 1.5 percent that same day):
Telephone companies and wireless service providers




• Teléfonos de Mexico, the country's largest telephone company, slipped 2.6
percent to 15.92 pesos.


• Wireless firm America Movil fell 1.6 percent to 8.82 pesos.


• Grupo Iusacell, the country's second-largest cellular phone company fell 5.1
percent to 3.56 pesos.




Soft drink and beer companies:




• Shares of Coca-Cola Femsa dropped 2.5 percent to 18.4 pesos.


• Shares of Pepsi- Gemex, Mexico's largest Pepsi-Cola bottler, closed unchanged
at 10.1 pesos.


• Shares of Grupo Modelo, Mexico's largest beer maker, fell 4 percent, to 9.7 pesos.


• Shares of Fomento Económico Mexicano, the second-largest beer maker in
Mexico and the parent company of the soft-drink bottler Coca-Cola Femsa, fell 2.8
percent to 31.5 pesos.


The Taxpayers’ reaction:




Infuriated taxpayers have flooded the offices of the judicial branch of “Hacienda”
with injunction applications. During January Hacienda employees expected to
receive up to 300 thousand “amparos” [Talamantes 2002], promoted by physical
and moral persons demanding the derogation of the “absurd” fiscal dispositions,
which will certainly smother, in my opinion, the bureaucratic machinery of federal
courts.




Business chambers and associations from the different affected sectors are
advising their members to seek a legal injunction (amparo) against the new code.


Companies such as Arancia Corn, Archer Daniels Midland Company and Cargill
Inc made public their decision to present a complaint before the World Trade
Organization in order to protect themselves from the new taxes [Menjido 2002].




Oddities and Contradictions of the New Tax Code:




The lack of care manifested by México’s legislative body not only stroke the most
representative sectors of the country’s economy, but also created confusion on
“how” these new laws would be applied and shaped fiscal paradoxes:




• In a country where anyone can buy a pre-paid mobile phone, incoming minutes
are free, and only a limited sector of the population can have access to regular
phone lines; cellular phones are considered luxurious under the new law. 19
million cellular phone lines are estimated to be active in Mexico and, definitely, the
wealthy people in Mexico does not account for 19 million inhabitants (nearly 20
percent of Mexico’s residents!).
• Under the new tax code a pair of rough steel toe boots worth approximately $20
(in fact any kind of boot that covers the ankle) is considered a luxury and should be
taxed at 20 percent; nevertheless a pair of crocodile shoes worth over $200 is not,
and should be taxed at only 15 percent.




• To practice nautical sports or to play golf are luxuries paying 20 percent in taxes;
to buy golf clubs or a yatch is charged with regular taxes.




• To buy salmon (in México it is usually cheaper than red snapper or tuna) is a
luxury; however, to buy Italian proscuito, at $25 a pound, is not.




• Perfumes, which may include any $2 scented face cream, are luxurious goods; to
buy a $200 Mont Blanc pen is not considered a luxury.




• Tin camping plates are a luxury, handmade chinaware is not.




Conclusions:


“In Mexico we have a fiscal reformation that instead of helping us is getting on our
way…” Eugenio Clariond, CEO of Grupo IMSA –Mexico’s top steel producer-
[Cariond 2002].
It is understood that the Mexican government is in need of more resources in order
to meet the people’s necessities; nevertheless I disagree on the way congress
pretends to obtain funds.


Tax collection should avoid causing business’ utilities to fall by means of legal
instruments; in fact, it must aim to increase those utilities; consequently when taxes
are applied the amount of money collected will also increase.




I think that a country’s tributary system should not be based mostly on income; for it
has proven to be unfair in a country like Mexico were informal economy is a serious
problem. Those who actually fulfil their duties paying their taxes, instead of being
relieved, will have to bear a heavier burden paying even more, while those who
have never paid any kind of income tax (which are estimated to be more than half
of the economic sector) will continue to enjoy their self-appointed tax exemptions.




Mexican taxpayers were, before the new law application, already overwhelmed by
taxes. If you buy a new car in Mexico you will have to pay 2 different taxes: The
sales tax (only once) and the New Car Ownership tax (once a year until the car’s
model is ten years old), along with the annual “license and registration” fee. In our
Juarez-El Paso community is ordinary to find Juarez’ residents waiting, up to 2
hours sometimes, on the international bridges just to be able to buy gasoline...
Why? Because, even when México is referred to as one of the world’s largest oil
producers –ranked 13-, fuel prices increase at a monthly rate (it’s true!) thanks to
taxes, setting fuel prices in México to almost twice the U.S. price.




I believe that instead of creating new taxes to increase the governments’ budget;
lawmakers should create a system that would force tax-evaders to pay; that is a
system that would evenly spread fiscal obligations over México’s workforce,
therefore increasing the government’s budget, and at the same time alleviate the
load on taxpayers.




The best way to reduce tax evasion is, in my opinion, to tax consumption instead of
income. Like that the number of taxpayers would automatically increase (even tax-
evaders would have to pay, willingly or not!); budget expenditures would decrease
since such taxes are easier to collect, and income tax payers’ contributions would
be less onerous.




President Fox’s proposal was extremist in the sense of taxing all kinds of foods,
books and medications; I think that this tax issue should have aimed to create an
adequate balance turning around the reduction of direct taxes (income) and the
increment of indirect taxes (consumption).




References:




Becker, Gary. “Critica Premio Nóbel Impuestos Especiales”, Palabra, January 19
2002, Sección A.
Cáceres, Jorge. “Ineficiente la Reforma Fiscal”, Crónica, January 9 2002, Finanzas.




Christman, John H. “Impacta la Reforma a Maquilas”, El Norte, January 25 2002,
Negocios.




Clariond, Eugenio. “Entrevista”, El Norte, March 10 2002, Negocios.




Garduño, Maria. “La Reforma Fiscal en Alimentos y Bebidas”, Reforma, March 17
2002, Buenamesa.




Mejido, Manuel. “Los Empresarios Impulsan una Contrarreforma Fiscal”, El Sol de
México, January 12 2002, Alto Poder.




Talamantes, Armando. “Prevén Hasta 300 Mil Amparos por Reforma”, El Norte,
February 4 2002, Negocios.