Mexico: Indirect Taxes In Mexican Economy

For years now the Government has directed its efforts to deal with unemployment, poverty, insecurity, lack of good health services, among others; but unfortunately without much success.

President Fox´s Administration has not been the exception, since trying to overcome such problems has become its priority. However, this requires spending significant amounts of money, which at the same time implies that the Government needs to raise substantially larger amounts than those being raised today.

In general, governments are financed through any (or all) of the following methods:

  • Nationalizing natural resources or activities
  • Contracting foreign debt
  • Increasing internal deficit
  • Increasing taxes

Previous Mexican Governments have resorted to all of the above methods with very different results. In the case of taxes, every year Mexican legislation has been amended, without ever being seriously reviewed and updated.

In Mexico, tax collection currently only finances 42% of public expenditure. This may be attributable to: a very formalist tax legislation, which makes proper payment difficult; a poor tax administration system and a small number of registered taxpayers.

Due to all of the above, tax collection represents a low percentage of gross national product (even lower than the average of the South American countries).

Tax experts have concluded that Latin American countries should only contemplate the possibility of financing their governments through an increase in taxes, and not through any other of the aforementioned financing methods.

However, since increasing income tax rates poses many obstacles, the best available short term solution is to tax consumption as oppossed to income. Even though indirect taxes may prove to be regressive, their redistributive effects are on the expense or consumption side and not on the collection side.

In Western European countries where consumption taxes represent a significant percentage of tax collection, their societies are more egalitarian, which does not occur in countries like the U.S.A. where consumption taxes are not as significant.

Countries that stress taxation on consumption, promote internal saving and their economy does not depend so much on foreign investment. Additionally, indirect taxes do not jeopardize production, labour nor investment.

As part of President Fox´s campaign promises was to improve the way of living of the poor (which represents a high percentage of Mexico´s population).

In order to accomplish the above, he needed to submit a tax bill to Congress which would allow his Administration to count with the necessary revenues.

On April 3, 2001 the aforementioned billed was submitted to Congress proposing the following basic tax amendments:

  • Income tax
    1. Decrease of the corporate and individual income tax rates.
    2. Elimination of 5% withholding tax on dividends.
    3. Elimination of certain special tax regimes.
    4. Calculation of inflation effects on an annual basis as opposed to a monthly basis.
    5. Allowing a one-time depreciation deduction.
    6. Changes in the calculation of tax cost basis of shares.
    7. Changes in the calculation of tax effects in a capital reduction.
    8. Elimination of certain exemptions for individuals.
    9. Standardization of withholding tax rates on payments to non-residents.
  • Value added tax
    1. Taxing with value added tax exempt items such as: food, medicine, books, transportation and tuition.
    2. Taxation on a cash flow basis.

As may be derived from the above, even though the proposed amendments are significant and the Government is expecting to have larger tax revenues, we are not facing a thorough change in the various tax laws, nor an update of the corresponding Regulations, which means that there is still a long way to go tax wise, and also, that the current Administration is basically counting on value added tax to achieve its income requirements.

To date, Congress has reacted in several ways to these proposed amendments, and formal discussions of the bill have not yet started. This may occur sometime between now and December, 2001, and maybe become effective January 2002. The wording of the final document poses a big question, given the fact that Mexico is going through a change in its political structure with a new president from a party that had never made it to presidency, and with almost all the different political parties being represented in Congress.

Whatever happens, one thing is clear: tax collection may increase if indeed the bill is approved as submitted to Congress, but this has to go hand-in-hand with an effort to improve the tax collection system, and the only way Mexico´s economy and society may benefit from said collection increase is by having a well defined national project and expenditure plan, together with a healthy economy and with well-intended politicians.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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