Mexico’s Labyrinth of Bizarre New Tax Laws

A few days ago, I tried to do something that used to be quite simple--I requested a restaurant receipt so I could deduct a business lunch on my Mexican income-tax return. A bureaucratic nightmare then began.

I was asked by the restaurant to provide a copy of my Mexican Federal Income Registration. I offered the one I always carry in my wallet but was told I would need a photocopy, as the restaurant would need to keep a copy. I was also asked to provide a signed letter swearing that I would indeed deduct the business lunch from my taxes--or be subject to an unspecified penalty.

If I met these requirements, the restaurant manager assured me, I would not only get my receipt; I would also be exempt from a new “luxury” tax that the federal government is assessing on meals in restaurants.

It’s not that the old ways were much better. The Mexican tax system has always been complex and unfair. It allowed millionaires to pay little or no tax while the middle class paid excessively. Despite the high taxes, the government provides completely inadequate public services.

For decades, it has been clear that Mexico needed to overhaul its tax system if it wanted to become a more competitive and fairer country. Proposals for fiscal reform have been floating around for years, always to be derailed by powerful special interests.

In March 2001, President Vicente Fox, a few months after becoming the first Mexican president ever to take power peacefully coming from an opposition party, submitted a proposal to Congress which would have applied a 15% value-added tax (IVA) on all products, including foods and medicines, which are presently exempt. Congress, which still has a PRI majority, rejected this proposal and, instead, enacted a wide array of special and “luxury” taxes that, rather than improving the system, have set it back.

The new rules for deducting business lunches are a consequence of a new 5% luxury tax, on top of a 15% IVA, on restaurant meals--unless the meal is a business expense, in which case the luxury tax does not apply. Other new taxes are equally strange and unwieldy. A luxury tax is applied to cellular phone service, top-of-the-line computers, boots and an assortment of other products. A special 10% tax is also being levied on soda sweetened with products other than sugar. New prohibitively high taxes have been applied to alcoholic beverages--a bottle of tequila, as a consequence, now costs more in Mexico than in the U.S. A new 3% wage tax is being levied on low salaries paid by employers.

Many of the new taxes are ostensibly unfair. The so-called luxury taxes are collected from average customers, but not from business ones. The tax on cellular phones not only punishes one of the few industries that has been growing and creating jobs during the present recession, but disregards the fact that, in Mexico, cellular telephones are not a luxury--there are 19 million wireless users in Mexico, as opposed to 13 million fixed-line customers, because many Mexican communities are simply not wired for telephones. The tax on computers is expected to deepen the digital divide between Mexico and the developed world, thus making Mexico less competitive. The tax on low wages discourages private firms from hiring people most in need of jobs.

The new taxes are also protectionist. The tax on soda has not been designed to raise revenue but rather to compel producers to switch from U.S.-made maize-based fructose sweetener to more expensive Mexican cane sugar. The tax, moreover, is pushing prices up for a product that millions of Mexicans drink because there is no safe drinking water available in many areas of the country.

The new taxes further complicate a system already known for its complexity. Red tape for businesses and the government will increase substantially. Restaurants, for example, will have to keep and relay to the government millions of federal income-tax registration copies and letters from patrons wanting to deduct their business lunches, and the government will have to process them. The new taxes are so unworkable that already, in the few weeks since they were enacted, the rules of application have twice had to be changed.

Special treatment for certain groups is maintained. Farmers and truck owners continue to get special privileges. Bureaucrats and high public officials are exempt from paying taxes on certain parts of their income.

The new taxes are also likely to prove ineffective for the purpose of collecting more government income. In the case of alcoholic beverages, for example, they will raise more revenue per unit sold, but sales have already dropped off, suggesting that in the end, distributors will pay less income tax rather than more. The inevitable layoffs of workers will also mean a reduction in tax revenues.

Although President Fox is not really responsible for the mess--the fiscal reforms he proposed in March of 2001 were much simpler and fairer--his administration is paying part of the political bill. Last month, Fox’s personal approval rating dropped below 50% for the first time since he became president in December 2000. Mexicans, unused to a divided government, can’t believe that Congress would act on an issue as important as taxes without the prodding of the president.

Fox has not ruled out the possibility of trying again to enact a true fiscal reform. He can’t do it now, because his party, the National Action Party (PAN), is in a minority position in Congress. But Fox’s political strategists believe that the PAN could become the majority party in the 2003 legislative elections.

Mexico’s economy will not collapse because of the new tax rules. The country still looks like a good bet for investors, especially when compared with such Latin American countries as Argentina or Venezuela. But Mexico has the potential to grow at a fast pace--maybe 5% or 6% a year for a decade of two. To do that, to follow the path of Chile instead of that of Argentina, the country must get rid of the many structural obstacles that have limited investment for generations. Overhauling the tax system to get a simpler and more investment-friendly fiscal environment is a crucial step.

So, what did Mexico’s legislators do instead? They made the country’s tax system even more complex and unfair--and in the process blew a momentous opportunity for positive change.

*

Sergio Sarmiento is a columnist for the Mexican daily Reforma.