November 2013 Article – Mexico’s Fiscal Reform

Posted on Posted in Monthly Article

Mexico is in a pickle. How can it collect more taxes to boost the revenues it needs to improve factors such as education and infrastructure without privatizing its state-owned oil company, PEMEX, and/or destroying economic sectors that are contributing to the country’s development? At present, the country collects approximately 10.6 percent of its Gross Domestic Product in taxes. This ranks it at the bottom of members of the Organization for Economic Cooperation and Development, and alongside countries that are nowhere near its stage of development. This is why PEMEX has become a golden goose in terms of generating badly needed revenues for the nation. To increase tax collection, Mexican President Enrique Peña Nieto has ambitiously launched his overarching fiscal reform which addresses everything from sin taxes on sodas, snacks, and pet food to how the country’s maquiladora (twin plant) industry is taxed.

Peña Nieto’s tax reform was recently approved by the Mexican Senate, after approval by the Mexican House. However, parts of this major legislation still have to be defined. What is known at this point is that at least two major economic sectors on the border, the maquiladora (maquilas) industry and the retail commerce trade will see major changes.

Apart from PEMEX, Mexico’s other golden goose for bringing in foreign revenues and investment is the maquiladora industry, long dominated by foreign companies establishing production plants in this country to remain competitive in the world market. Maquilas account for billions of exports from Mexico to the world and they are responsible for billions of dollars’ worth of investment and hundreds of thousands of jobs that Mexicans currently occupy in this production sector. However, many people associated with the maquila industry are arguing that the fiscal reform could serve to kill this other golden goose.

Up until the current fiscal reform, Mexico’s interior was subject to a value-added tax (IVA) on merchandise of 16 percent, while the border region’s IVA was 11 percent in order to encourage Mexican border residents to shop in Mexican stores rather than crossing over to U.S. cities where the sales tax is generally less. The reform increases the border IVA to 16 percent, equal to that of the interior.

Maquilas, were previously not subject to IVA on the import of the components and supplies that are used in the production process to make finished products. This is a cornerstone of the maquila industry that has made foreign investment in this sector so proliferate. Under the new tax reform, the exemption would be lifted, but maquilas would get a refund on this tax. However, the details on this refund are still uncertain and the lifting of this exemption will not begin until January 2015. Many maquila owners are extremely concerned about what the imposition of the IVA on their imports will do to their cash flow and their ability to remain competitive against other regions of the world. The fiscal reform also raises the corporate tax paid by maquilas from 17.5 percent to more than 30 percent. This part of the plan also needs to be defined.

On the retail side of the equation, raising the IVA by 5 percent could cause more Mexican shoppers to flock to the U.S. side of the border to purchase their goods. If a Mexican family spends $300 on groceries and supplies, a 16 percent IVA would result in a $48 tax. If this family shops in a place such as El Paso, an 8.25 percent tax would result in only $24.75 in taxes on the same purchase. Other border communities such as Santa Teresa (6.375 percent) have an even lower sales tax. The differences in taxes could make a trip to the U.S. side of the border worth the gas and time and could put revenues in U.S. merchants’ pockets.

As the details of the fiscal reform are put in place, many people are wondering how Mexico’s competitiveness will be affected by the changes in the way maquilas are taxed and whether Mexico’s border retail sector will see a decline. As a small business owner, I can’t imagine my corporate taxes being nearly doubled or my cash flow being interrupted, even if I have a couple of years to prepare for this change. It would seem that the Mexican federal government would take every precaution possible to ensure that Mexico’s economic growth is not hindered by the fiscal reform and that any tax changes would be gradually phased in over an acceptable period of time.

However, it seems like President Peña Nieto, who has been in office less than a year and is still on his political honeymoon, sees a window of opportunity to effect changes that might be harder to address as his time in office grows longer. U.S. border communities could benefit from increased patronage from Mexican shoppers due to the changes. But dealing with an avalanche of new taxes could hurt the competitiveness of maquilas and some may opt to locate their production elsewhere. U.S. firms that are located in the border region supplying the billions of dollars of production inputs for the maquilas could also be negatively impacted.