Cablegate: Mexico's Maquilas Claim New Tax Could Kill

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PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #4282/01 2222147
ZNR UUUUU ZZH
P 102147Z AUG 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 8381
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEHC/DEPT OF LABOR WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RHEHNSC/NSC WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 03 MEXICO 004282

SIPDIS

SENSITIVE
SIPDIS

SECSTATE FOR A/S SHANNON
SECSTATE FOR WHA/MEX, WHA/ESP, EB/IFD/OMA, EB/IFD/OIA
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GWORD
TREASURY FOR IA (ALICE FAIBISHENKO)
SECSTATE PASS TO USTR (EISSENSTAT/MELLE)
SECSTATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)
NSC FOR DAN FISK

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV ELAB MX
SUBJECT: MEXICO'S MAQUILAS CLAIM NEW TAX COULD KILL
INDUSTRY - BUT THE REAL PROBLEM IS PAYROLL TAXES

REF: A. MEXICO 3246

B. MEXICO 3859
C. MEXICO 4151
D. MEXICO 4191
E. MEXICO 4236
F. MEXICO 4280

Summary and Introduction
--------------------------

1. (U) Summary: Econoff spoke with representatives from the
National Council for the Maquiladora Export Industry (CNIME)
August 7 regarding the effects the new Single Rate Business
Tax (CETU) will have on the industry. The President, Jose
Jesus de Calleros, said that CNIME supports the concept of
the tax, but the way it is currently planned could kill the
industry as it is a huge increase and eats up profits. The
main concern is that labor cost deductions are not allowed.
While, even with some of the discussed changes, the tax will
lead to an increase in taxes for the industry, it is unlikely
that the CETU will lead to the end of maquiladoras in Mexico.
End Summary.

CNIME Supports CETU, BUT...
---------------------------

2. (U) CNMIE President Calleros stressed that the industry
does not oppose the CETU and they understand that reform is
necessary, particularly in light of declining oil reserves.
He said that CNIME wanted to suggest modifications that would
make the CETU work. Specifically, he said that maquilas
already pay taxes and do not want to pay more than they
already do. He said that the administration presented the
CETU too hastily and without proper research into its
effects. The Director of CNIME's Fiscal Committee, Ignacio
Valdes, explained that the CETU is a tax on production, and
since the maquila industry accounts for 40 percent of the
country,s production, they are most acutely affected.
Additionally, he said that not only do maquilas pay taxes as
a company, they pay employees who, in turn, pay Value Added
Tax when they purchase goods.

A Maquila Tax Primer
--------------------

3. (U) By law, maquilas have a minimum profit level of
between 6.5 and 6.9 percent for tax purposes. They are then
taxed 28 percent on their profits. Earlier this decade, to
keep the maquila industry from losing business to China,
President Fox issued a decree halving the tax rate to 14
percent of profits. For example, using round numbers in USD
for simplicity,

Income = 106.5 USD
Costs = 100 USD
Profit = 6.5 USD
Tax Rate = 28 percent
Decree Tax Rate = 14 percent
Actual Taxes Paid = 91 US cents

While the rate is 14 percent of profit, it is less than 1
percent of income.

4. (U) The CETU in comparison, bases the tax on income and
not profit. The maquila industry is labor intensive with the
majority of its costs going to labor. The CETU currently
does not allow deductions for labor costs although it does
provide credit for income tax withheld. Using the same
maquila from the example above,

Income = 106.5 USD
Deductible Costs = 30 USD
Tax Base = 76.5 USD
Tax Rate = 19 percent
Tax = 14.53 USD
Paid by company = 8.65 USD

According to the figures provided by CNIME the company in the
example above will pay 850 percent more in taxes.

MEXICO 00004282 002 OF 003

CETU Hurts What It Is Supposed to Help
--------------------------------------

5. (U) CNIME highlighted the danger the CETU poses to the two
main areas the Government of Mexico (GOM) is trying to
promote: investments and job creation. Industry
representatives feel that if the CETU is implemented without
changes, investors will shift funds to countries with a more
competitive tax structure. Calleros said that other
countries have studied and learned from Mexico's maquila
industry and provide a viable alternative if the GOM
implements the CETU. Calleros also worried that the CETU
would stifle job creation, essential to increasing Mexican
growth.

6. (U) CNIME maintains that anything that threatens the
maquila industry threatens competitiveness and the overall
well being of the economy. Valdes noted that the maquila
industry stimulates consumption by paying workers who, in
turn, consume. Maquilas employ 1.6 million directly and
create another 5 million jobs indirectly. Forty percent of
participants in the Mexican social security system are
involved in the maquila sector.

CNIME's Objections
------------------

7. (U) CNIME's main objection to the CETU is the lack of
deductions, particularly for the various labor and social
service costs maquilas pay. A large part of the maquila
industry is labor intensive and the payments to employees'
pension and housing plans constitute 70 percent of business
costs. Under the CETU, salary costs and housing and social
security fund contributions are not deductible. Jesus de
Calleros said that, it is contradictory for Mexico, trying to
promote job creation, to penalize companies that hire more
employees.

8. (U) The CETU also eliminates key benefits that the maquila
industry currently enjoys such as a 50 percent discount on
taxes and stimulus for research and development. The CETU
also does not allow deductions for the temporary export of
goods. According to CNIME, removing these deductions would
eliminate the main draw for companies to Mexico's maquila
sector. Additionally, companies that also do business in the
United States and other countries that do not recognize the
CETU for reciprocal taxation purposes, would be doubly taxed,
further decreasing Mexico,s competitive edge.

GOM Disagrees
-------------

9. (U) CNIME complains that, even though the Secretariat of
Finance (Hacienda) maintains that the tax is meant to target
tax evaders and those who structure their books so they pay
no taxes, maquilas, taxes will increase between 500 and 800
percent. CNIME and Hacienda disagree on the effect the tax
will have on the industry. According to CNIME, Hacienda
based its figures on broad macro economic data which does not
show the true effect on companies because it does not take
into account the different expense structures of firms in
different sectors and with different numbers of employees.
They will be working with Hacienda over the coming weeks to
discuss the numerical data.

CNIME Will Continue Fight
-------------------------

10. (U) Valdes said extra revenue raised by the CETU does not
warrant risking jobs and future investment. He argued that
the additional money that the government intends to collect
from companies that are already paying taxes would be better
left in the private sector where the money could be used to
continue investments and create more jobs. The alternative
would be to overtax companies, leading them to invest less
and create fewer jobs, which in turn would increase the
demand for government social programs putting more pressure
on government finances.

MEXICO 00004282 003 OF 003

11. (U) Jesus de Calleros reiterated that the CETU does not
need to be eliminated, only modified so that it does not hurt
competitiveness. He said that CNIME had been in continual
contact with members of the relevant committees of the
Mexican Senate and Chamber of Deputies to work out changes
that would help the maquila industry. He stressed that the
maquila program had survived for 40 years and had generated
technology advances, employment and economic growth which
would all be under threat if the CETU were approved without
considering the maquila industry.

Comment
-------

12. (SBU) If the figures provided by CNIME are correct, many
maquila companies will pay more in taxes than they make in
profits. The GOM must increase tax collection, however, and
any concessions granted to the maquila industry would lead to
demands for concessions from other industries. The best
solution would be a labor reform that decreases the large
amount of money companies must pay for the wide array of
government "social security" type payments regardless of
whether their employees benefit from the government programs
being funded. Such mandatory payroll expenses include
payments for housing, daycare, pensions, health care and
holiday bonuses. Since the amount firms must pay is tied to
their number of workers, labor-intensive industries would be
hurt if they can no longer deduct such fees from their
overall taxes. These long-standing payroll taxes help
support Mexico,s social welfare bureaucracy, and are viewed
(at least politically) as providing a social safety net for
those workers employed
in the formal economy.

13. (SBU) It is unlikely the situation is as dire as CNIME
paints it. Companies with long histories in Mexico will do
as much as possible to avoid beginning anew in another
country. We believe investors would also be willing to give
up some profit if they believed it meant an overall increase
to Mexico's competitiveness and future higher returns. Most
investors in Mexico agree on the urgent need to increase tax
collections in Mexico, but would rather the large informal
economy and other tax evaders be taxed rather than only
raising taxes on those companies that are registered in the
formal economy and already paying some taxes. The Mexican
Congress is considering reducing the CETU rate by 3 percent
or allowing certain additional deductions, which would be the
most likely remedies for the maquila industry. That being
said, if the CETU is passed in any meaningful form, the
industry will have to accept that they will be contributing
more to the Mexican coffers than in the past. End Comment

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