tax incentives for investm ent and their impact on the

134

Ethos • Public Policy Lab

TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO GENERAL DIRECTOR José Luis Chicoma

PROJECT COORDINATOR Liliana Alvarado Baena

All rights reserved. This publication and parts hereof may not be reproduced, stored in any system, or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any means whatsoever, without the prior permission of Ethos Public Policy Lab.

DESIGN AND COVER Cerca Diseño First Edition: May 2014 A.R.R. © Avance-Análisis, Investigación y Estudios para el Desarrollo, A.C.

WORKING GROUP Renato Busquets Sordo, Jaime García Gómez, Junior Alfredo Martínez Hernández, José Antonio Mendoza García, Alicia Santana Cartas, Eduardo Sierra Albarrán, and Dalia Toledo Toledo.

Ethos Public Policy Lab Enrique Rébsamen 1108 Col. Del Valle 03100

Ethos Public Policy Lab acknowledges

Mexico City, Federal District

the support of the United States Agency for International Development (USAID) and the valuable input from Patricia López Rodríguez, Héctor Moreno Moreno, and Humberto Soto de la Rosa for this publication.

+52 (55) 53350670

We acknowledge the support of Alejandra Brambila and Andrea Huerta in producing this document. Its content and conclusions are the responsibility of Ethos Public Policy Lab and do not represent the viewpoints or opinions of the United States Agency for International Development (USAID), the United States Government, or the public officials engaged in the programs under study.

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ISBN: 978-607-96546-0-3

Acronyms

BANCOMEXT. National Bank for Foreign Trade DIIAF. Immediate Deduction of Fixed Asset Investments ECLAC. Economic Commission for Latin America and the Caribbean FDI. Foreign Direct Investment GCI. Global Competitiveness Index GDP. Gross Domestic Product IMCO. Mexican Institute for Competitiveness IMD. International Institute for Management Development INEGI. Mexican Institute of Statistics and Geography ISN. Payroll Tax LISR. Income Tax Law MOI. Initial Investment MSMEs. Micro, Small, and Medium Enterprises OECD. Organization for Economic Cooperation and Development PEF. Federal Expenditures Budget PGF. Tax Expenditure Budget PSM. Propensity Score Matching SAT. Tax Administration Service SCNM. Mexican System of National Accounts SHCP. Ministry of Finance and Public Credit SMEs. Small and Medium Enterprises TFP. Total Factor Productivity WB. World Bank WEF. World Economic Forum

Contents

4


Executive Summary 6 Introduction 8 1. Determinants of Competitiveness 9 2. How Does Productivity Make a Country More Competitive? 15 3. The Role of the Tax System in Promoting Investment and Productivity 23 3. 1. Supporting Enterprises: Tax Expenditures 26 3.1.1. Overview of the Immediate Deduction of Fixed Asset Investments 31 4. Why Invest in Fixed Assets? 39 5. Boosting Local Development through Investment Incentives 45 6. Immediate Deduction of Fixed Asset Investments and its Impact on Competitiveness 51 6.1 About the Evaluation Method 53 6.2. Results 54 6.2.1. Efficiency of the Immediate Deduction of Fixed Asset Investments: The Cost Outweighs the Benefits 54 6.2.2. On the Ineffectiveness of the Immediate Deduction of Fixed Asset Investments 59 6.2.3. Entrepreneur Opinions on the Immediate Deduction of Fixed Asset Investments 71

7. Conclusions and Recommendations 85 Bibliography 90 Appendix 1. International Benchmark of Global Investment Deduction Schemes 99 Appendix 2. Investment Incentives in Mexican States 104 Appendix 3. Methodology 107 Appendix 4. Productive Loans and Support from Federal Government 118 Appendix 5. International Tax Simplification Measures 128

TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

5

Executive Summary Tax incentives can serve as a powerful public policy instrument for promoting business investment, productivity, and competitiveness. However, their potential in México has been affected because decisions about their implementation, modification, or elimination have been made, in most cases, without any prior evaluation of their possible impact or any extensive analysis of their outcomes. The case of the Immediate Deduction of Fixed Asset Investments (DIIAF) is indicative of this situation. In a context such as Mexico’s, where government resources are scarce and there is a constant need to implement public policy that will boost the country’s competitiveness, decision making needs to be well-informed. In this respect, the main objective of this study is to investigate whether the tax incentive known as DIIAF, which was repealed under the 2014 Social and Tax Reform, was an effective mechanism for promoting investment and, consequently, business productivity and competitiveness in the country. Furthermore, this study will analyze the implications of this decision and will propose recommendations in view of the present reality. This being the case, the first chapters of this study will look at the relationship between tax incentives and competitiveness. We will first outline how certain tax expenditures can encourage investment by reducing the cost of fixed assets. Then, we will analyze how greater investment in fixed assets can have a direct impact on enterprises productivity by allowing for the replacement or increase of capital stock. Finally, we will explain how the points mentioned above can result in greater competitiveness due to the central role that company productivity plays in this. The subsequent chapters will evaluate to what extent the DIIAF, by boosting investment, fulfilled its purpose. This evaluation will mainly be based on three analyses: i) cost-benefit analysis (efficiency); ii) effectiveness analysis, and; iii) entrepreneurs’ perceptions of the DIIAF’s implementation. From the above, the study’s conclusions and recommendations will be drawn. The key findings of this study include the following:

6


• The cost-benefit analysis indicates that the DIIAF was an inefficient and costly incentive, since, for the duration of its application, its costs outweighed its benefits. • According to the effectiveness analysis, the DIIAF did not boost the investment, labor productivity, or total factor productivity of enterprises in Mexico. • A dearth of financing, scant government support and a lack of tax incentives are the greatest factors inhibiting business investment in the country. In fact, 63% of the companies surveyed revealed that self-funding was their main source of finance. • Of the total investment of enterprises in fixed assets, the DIIAF was only used in 11%. Only 15% of entrepreneurs claimed that the DIIAF was instrumental in the acquisition of fixed assets. • Entrepreneurs believe that investment in fixed assets is the main determinant for firm productivity in the country. • Entrepreneurs consider that high tax rates are the factor that hinders competitiveness the most, whereas administrative simplification, the availability of tax incentives, and a fair tax system are the aspects that benefit competitiveness the most.

• According to entrepreneurs, the following are key changes to the DIIAF’s design that could enhance its operability: removing the incentive’s geographical lock, raising deduction percentages, getting rid of unnecessary requirements, simplifying its implementation, and guaranteeing the continuation of the incentive to facilitate medium-to-long term investment planning. • As alternatives to the DIIAF, entrepreneurs suggest the possibility of greater financing and a more attractive deduction scheme. • Internationally, it is common for governments to combine straight-line tax depreciation with immediate and/or accelerated deduction, as is the case in the United States, some European countries, and Latin American countries with a similar stage of development as Mexico, such as Argentina, Chile, Brazil, and Colombia. • The international benchmark revealed that the use of immediate deduction schemes on investments is generally targeted at certain strategic sectors or geographical areas, and depends on the type and/or value of the asset as well as the size of the company.


7

Introduction In a globalized world where the markets are more open and integrated than ever, competitiveness is a fundamental issue. For this reason, most developed and emerging economies are looking to permanently implement policies that result in successful domestic and foreign market participation. In this respect, Mexico has not been the exception, particularly when we consider that the levels of competitiveness recorded in recent years have been far from ideal. Although at present, there is no widely accepted definition or widespread consensus on the determinants of competitiveness, most international organizations and experts on the subject agree that company productivity is a key factor. This is because as the efficiency of companies increases, economic sectors and productive regions emerge, bringing with them more competitive economies. For this reason, a number of government actions that have the objective of promoting business productivity exist. Some of these are targeted at improving the efficiency of factors of production: particularly labor, capital, technology, and innovation. In Mexico, a series of programs and actions have been implemented to achieve this purpose. In particular, the DIIAF was in force as part of the national tax structure between 2002 and 2013, with the principal aim of increasing investment in capital assets. 8


However, the recent repeal of this incentive and the lack of other fiscal alternatives aimed at promoting investment could impact negatively on productivity. This has led a number of questions to emerge, such as: What effect did the DIIAF have on enterprises investment and productivity? Which were greater: the costs or the benefits of this tax deduction? Was DIIAF’s elimination relevant? Were mistakes made in the DIIAF’s design and implementation which limited its effectiveness, and if so, what were they? What other tax policy measure could prove effective in boosting investment? This study attempts to answer these questions by evaluating the performance of the DIIAF. For this purpose, a survey was designed and prepared to collect detailed information on company investment, productivity, and competitiveness, and on entrepreneurs’ perceptions of the usefulness of the DIIAF. Based on the outcomes of this evaluation, we have drawn up a list of recommendations, which are targeted at decision makers to encourage increased investment through the tax system. Furthermore, by deepening knowledge of the effectiveness of tax expenditures in Mexico, this study aims to raise awareness among public officials, lawmakers, academics, and civil society about the importance of evaluating and overseeing tax expenditures, particularly those with the potential to strengthen the country’s levels of competitiveness.

CHAPTER 1.

DETERMINANTS OF COMPETITIVENESS Competitiveness is a priority on the public agendas of most nations, and a multitude of definitions exist on the subject. According to the World Economic Forum (WEF), competitiveness is “the set of institutions, policies, and factors that determine the level of productivity of a country” (Schwab, 2012, p. 4). Alternately, the Inter-American Development Bank says that “an economy is more competitive when companies operate in an environment that is conducive to the sustained growth of productivity and per capita income” (2001, p. 11). According to the International Institute for Management Development (IMD), competitiveness is “a field of economic theory, which analyzes the facts and policies that shape the ability of a nation to create and maintain an environment that sustains more value creation for its enterprises and more prosperity for its people” (Garelli, 2006, p. 11). Similarly, the Economic Commission for Latin America and the Caribbean (ECLAC) states that “competitiveness is a condition deriving from the profitability of firms in their production activities in competitive markets” (2006, p. 7). Finally, Porter, one of the leading experts in the subject, says, “the only meaningful concept of competitiveness at the national level is productivity. The principal goal of a nation is to produce a high and rising standard of living for its citizens. The ability to do so depends on the productivity with which a nation’s labor and capital are employed” (2008, p. 176). As Image 1 shows, the different meanings of competitiveness are also reflected in the main indices by which it is measured, such as the WEF’s Global Competitiveness Index (GCI), Doing Business by the World Bank (WB), The Heritage Foundation’s Index of Economic Freedom, and the IMD’s World Competitiveness Index. Each of these contains determinants as varied as rule of law, labor market efficiency, access to loans, international trade, a stable political system, health, education, sustainable environmental management, the tax system, productivity, etc. Despite the different definitions and the lack of consensus over the determinants of competitiveness, most international organizations and experts agree that productivity is a core component of it.


9

banK

finanCE

WORK

labor educaTION financiAL ATTAINMENT FOREIGN

internaTIONAL

infraestructurE

TIME

agriculturE BUSINESS GOVERNANCE PROPERTY

EXPENDITURE

EFFICIENCY

ENTERPRISE sector COMPANIES

GOVERNMENT variabiliTY importS

ConsumPTION

POLICY

POWER

HEALTH

contraCTS

productiviTY GDP WATER

GROWTH

REVENUE

QUALITY

TAX EAP RATE HEALTH INTERNATIONAL

WOMEN AVERAGE

MARKET

CORRUPTION

capital regulatorY total educaTION COUNTRIES

INVESTMENT

Image 1. Productivity is a leading factor in competitiveness indices

Source: compiled privately based on information from different competitiveness indices.

Competitiveness can be analyzed from three different perspectives: micro, meso, or macro. At enterprise level (micro), competitiveness focuses on “matching or beating the world’s best firms in cost and quality of goods” (Blunck, 2006, p. 1). At the meso level, an industry or region is competitive if its Total Factor Productivity (TFP) “is equal to or greater than that of its competitors and if its average unit costs are equal to or lower than those of its competitors” (Padilla, 2006, p. 8). The competitiveness of a country (macro) is a more complex issue, since it means defining attributes that create a climate suitable for enterprise development. 10


In the view of some authors, the competitiveness of countries is closely linked to the competitiveness of enterprises. For instance, the Center of Competitiveness Studies maintains that the competitive advantage of an enterprise depends on the industrial sector or region in which it is engaged. Moreover, “the competitiveness of an industry or region is subject to the policies, infrastructure, and other factors provided to them by the country. Whereas, an industry will be profitable insofar as the units by which it is composed are also profitable and hence, a country will be competitive if its industries and regions are productive” (Center of Competitiveness Studies, 2010, p. 3).

BOX 1.

COMPETITIVENESS IN MEXICO Although Mexico has made progress in the area of macroeconomic stability, it has been unable to generate sustained economic growth driven by a strong domestic market and a competitive economy. One of the indicators most often used to measure the competitiveness of a number of the world’s countries is the GCI produced by the WEF. The 2013-2014 edition of this index puts Mexico in 55th place out of a total of 148 countries, thus placing it in the top half of the league table, yet behind other Latin American countries such as Chile, Panama, and Costa Rica (see Graph 1).

Graph 1. Competitiveness in Mexico and other countries according to the GCI COUNTRY/POSITION 6.0

SWITZERLAND 1 SINGAPORE 2

5.5

N. ZEALAND 18

RATING

5.0

OECD AVERAGE 4.5

4.0

USA 5 CHINA 29

CHILE 34 PANAMA 40 COSTA RICA MEXICO 55 54

LATIN AMERICA AND THE CARIBBEAN AVERAGE

3.5

BRAZIL 56

PERU 61

COLOMBIA 69 ARGENTINA 104 VENEZUELA 134

3.0

Source: compiled privately based on the 2013-2014 GCI.

The GCI gives Mexico a rating of 4.34 out of 7. In general, issues relating to institutions, quality of education, goods market inefficiency and, in particular, organized crime and violence, lack of trust in public security services, and recruitment practices are the main factors that limit economic competition in the country. Likewise, high rates of tax and other government market regulations (such as anti-monopoly, agrarian, and labor laws) also have a negative impact on competitiveness. By contrast, its macroeconomic environment, market size, and Foreign Direct Investment and technology transfer are aspects that have helped Mexico to improve its ranking in recent years.


11

As we can see from Graph 2, Mexico’s ranking in the GCI has remained relatively stable since it was first published in 2004. However, we should note that the number of countries evaluated has increased by almost a third, which has influenced a better positioning of Mexico in relative terms. In 2011, the country recorded its lowest level of competitiveness, coming in at 66th place. However, between 2011 and 2014, Mexico has evolved positively, and is now closing in on the topranked countries occupying the top third tier.

Graph 2. Ten years of stalled competitiveness

140

131 117

120 100

134

133

122

142

144

148

TOTAL COUNTRIES EVALUATED

104

102

80 60

139

47

48

55

52

52

60

60

40

66

58

53

55

MEXICO´S RANKING

20 0 2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Source: compiled privately based on the 2003-2004 to 2013-2014 GCIs.

The last GCI report ranks Switzerland and Singapore as the most competitive economies. These two countries generally tend to occupy the top places in each of the twelve pillars evaluated. Singapore stands out in global terms for the efficiency of its labor and goods markets, whereas Switzerland excels in business sophistication and innovation. Mexico, on the other hand, is rated highly in terms of its market size and macroeconomic stability. Compared with the two most competitive economies, we see that the only attribute in which Mexico ranks higher is in market size. By contrast, Singapore and Switzerland have a clear lead in the other eleven pillars (see Graph 3).

12


Graph 3. How do we rate alongside the most competitive nations? 1. InstituTIONS 1

12. InnovaTION

2. infraestructurE

21 41

11. BUSINESS SOPHISTICATION

3. MACROECONOMIC ENVIRONMENT

61 81 101

10. MARKET SIZE

4. HEALTH AND PRIMARY EDUCATION

5. HIGHER EDUCATION AND TRAINING

9. TECHNOLOGICAL READINESS 8. FINANCIAL MARKET DEVELOPMENT

7. LABOR MARKET EFFICIENCY

SWITZERLAND

singapORE

6. GOODS MARKET EFFICIENCY

mExico

Source: compiled privately based on the 2013-2014 GCI.

Other competitiveness indicators show some areas of opportunity for Mexico. The IMD showed in its 2013 World Competitiveness Index that economic performance was the variable that boosted the country’s competitiveness the most. By contrast, it is inhibited by its infrastructure. Doing Business 2014 shows that registering property, getting electricity, and paying taxes are the areas that must be improved if the country is to raise its competitiveness. With regard to paying taxes, although Mexico does not have high amounts of tax, a lot of time and resources are employed in its collection. In this index, resolving insolvency,1 efficiency in dealing with construction permits, and the ease of obtaining credit information are the variables where Mexico scores best.

1 This refers to the time and cost required to resolve a bankruptcy event. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

13

The 2013 Index of Economic Freedom produced by The Heritage Foundation shows that a lack of labor freedom,2 corruption, and inadequacies in terms of property rights downgrade Mexico’s competitiveness. By contract, factors such as business freedom3 have had a positive influence on the final outcome. This index also underlines that, although Mexico does not score highly in fiscal freedom,4 this is at an acceptable level compared to the rest of the countries studied. Finally, in 2013, the International Competitiveness Index produced by the Mexican Institute for Competitiveness (IMCO) ranked Mexico in 32nd place out of 46 nations evaluated, the same position it held eleven years ago. “Mexico’s stagnation can be put down to several reasons, perhaps the most important of which is the country’s inability to turn increased productivity into sustained growth” (IMCO, 2013, p. 153). More specifically, Mexico’s competitiveness is diminished as a result of its lack of sophistication and innovation, the inadequacies of its factor market (supplies and labor), and the poor performance of its innovate sectors, such as its financial and telecommunication sectors, which impact the productivity of other sectors. The only area in which Mexico scores at an acceptable level is economic stability.

How can Mexico boost its competitiveness and climb the world rankings? The different competitiveness indices serve as an essential metric for comparing the success or failure of the institutional and economic arrangements that set apart those countries with strong, dynamic economies from those that are lagging behind. In this respect, the above mentioned indices suggest that more resources and/or better strategies must be focused towards reducing corruption and violence, increasing the quality of education, ensuring the protection of property and labor rights, reforming the tax system and making it more efficient and, most importantly, increasing productivity. This final aspect will be the key to producing positive externalities that will raise the country’s competitiveness.

The fact that productivity is an essential component of competitiveness leads us to carry out a detailed analysis of the elements that make the country’s enterprises more competitive. One way of achieving this is to improve the efficiency of the factors which play a part in the production process, one of which is capital. In the following chapters, we will investigate how the tax system can play its part in boosting investment in capital and particularly, fixed assets.

2 The labor freedom indicator looks at the regulatory and legal framework governing dealings in the market. 3 Business freedom measures the ability to open, operate, and close down a business. 4 Fiscal freedom measures the tax burden imposed by the government as a percentage of GDP. 14


CHAPTER 2.

How Does Productivity Make a Country More Competitive? Simply put, productivity measures the output produced from a certain amount of inputs, which is to say, it measures efficiency in the production of goods and services. In light of this, the National Institute of Statistics and Geography (INEGI) states that increased productivity involves producing more with the same number of inputs or maintaining the same volume of production using a lower amount of inputs (2012). The Mexican Federal Labor Law defines productivity as: the outcome of optimizing the human, material, financial, technological, and organizational factors that exist in an enterprise, branch, or sector for the manufacturing of goods or provision of services, with the objective of promoting its competitiveness and sustainability, improving its capacity, technology, and organization, and increasing revenue, the well-being of workers and distributing benefits fairly, at the local, state, regional, national, and international level, according to the market to which it has access (2013, Art. 153-I). The productivity of an enterprise can be measured using different methods by taking either the value added in production or gross product.5

5 When measuring productivity by value added, the raw material costs of the final stage of the production process are subtracted from the value of the end product. Measuring productivity by gross product takes into account the value of the end product only. For example, a firm sells a desk for 600 pesos, but the raw materials purchased in a previous stage of the production process cost 500 pesos. When calculating productivity by value added, the figure we get is 100, which is the sum of the value of the end product (600 pesos) less the cost of the raw materials purchased during a previous stage of the production process (500 pesos). Whereas, when calculating productivity by gross product, the value we get is 600. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

15

In both cases, we can calculate either the

innovative (Álvarez, Bravo, & Navarro, 2011).

productivity of each factor of production (single-

According to the United States Bureau of Labor

factor productivity) or the combination of several

Statistics

factors used in the production process (multi-

measures the efficiency with which inputs are

factor productivity).

used, and the effects of other variables, such as

6

The estimation of single-factor productivity is

(2013),

multi-factor

productivity

levels of research and development.

generally of limited precision, since this calculation

• Investment in technology.

does not reflect the influence of other elements.

technology has a number of effects on enterprise

By contrast, measuring multi-factor productivity

productivity, such as greater availability and better

provides a more complete overview of production

use of information for decision making purposes.

process efficiency, since this information is

Technology also encourages cost reduction,

disaggregated. Until recently, the INEGI only

better interaction with customers, and improved

calculated single-factor productivity (specifically in

product quality, among other benefits. With this

relation to labor in Mexico), since there was limited

in mind, Salgado & Bernal (2011) note that the

information available with respect to capital.

main determinant of multi-factor productivity in

However, the institution recently published its TFP

the Mexican manufacturing sector is technology

estimates for the first time in its document “Total

uptake.

Factor Productivity 1990-2011.”

The use of

In addition to the impact of investment in fixed

• Level of competition within the industry. A highly competitive sector generates

assets on enterprise productivity, which is outlined

incentives for enterprises to constantly look for new

further on, the literature also mentions other

ways of increasing productivity and diversifying

variables affecting the efficiency of business

their products in order to avoid being squeezed

production processes, such as:

out of the market. Using information from the WB’s

• Investment in research and development. Greater spending on research and development increases the likelihood that companies will make their production processes

Enterprise Surveys, Ospina and Schiffbauer (2010) analyzed 27 countries in Eastern Europe and Central Asia and found that greater levels of competition lead to greater productivity. Similarly, Salgado and Bernal (2011) found that one determinant of multifactor productivity in the Mexican manufacturing

6 Generally, when calculating single-factor productivity by either the gross-product or value-added method, we divide the total production or sales of an enterprise, sector, or economy by the quantity of the factor of production being calculated that is used. Multi-factor productivity is calculated by dividing the value of everything produced or sold by the sum of two or more production factors used. 16


industry is competition within the sector.

• Improved organization of the production process. The development

decrease and they will therefore have fewer

of strategies or the implementation of continual

fixed assets, or invest in technology, resulting in a

improvement processes (such as performance or

loss of enterprise competitiveness.

total quality management, process re-engineering, etc.) have a direct impact on the cost, quantity, and quality of goods produced and overall business performance. According to Fernández, “continual improvement is a tool for increased productivity, encouraging the stable and consistent growth of all segments in a process” (2010, p. 29).

• Input costs.

resources available to increase production, acquire

• Labor regulations.

Labor regulations

restrict or encourage productivity. A study of sixteen Organization for Economic Co-operation and Development (OECD) countries found that restrictive dismissal regulations have a negative impact on the TFP of some industries and sectors. These restrictive regulations also have a negative

According to microeconomic

impact on the TFP of the economy (Bassanini,

theory, in view of the restricted nature of an

Nunziata & Venn, 2009). According to Kaplan (2009),

enterprise’s budget, an increase in the price of its

there is consistent evidence to suggest that tight

inputs could cause production to fall, since the firm

labor regulations, such as high compensation

would in turn have to purchase a less of them. If

payouts by law or restrictions on working hours, can

the firm wanted to maintain its level of production,

prevent labor markets from operating effectively.

it would have to increase the price of its goods, which would place it at a disadvantage compared to its competitors. On the other hand, a reduction in input costs could lead to greater productivity and/ or more competitive pricing. As such, the input costs variable is closely linked to enterprise productivity and competitiveness.

• Access to financing. High financing costs or credit access restrictions have a negative impact on enterprises’ investment projects. Jeong & Townsend (2007) studied TFP determinants in Thailand over a twenty year period and found that changes in multifactor productivity can be explained by the level of financial deepening (percentage of the economy

• Operating and maintenance costs.

with access to formal credit) and occupational

Electricity, drinking water, gas, leasing property, and

change (change from workers to entrepreneurs).

transportation generate major costs for enterprises. Economic theory suggests that the impact of operating and maintenance costs on enterprise productivity is similar to that of input costs, as described above. If, for instance, transportation costs increase, the net profit earned by entrepreneurs will


17

BOX 2.

Productivity in Mexico In terms of labor productivity, in 2012 Mexico scored last out of all OECD countries, with Mexican workers producing an average of 19 dollars per hour worked, compared to Chile 27, South Korea 27, New Zealand 37, Japan 40, Germany 58, United States 62 and Norway 87 (OECD, 2013) However, during the same year, the country’s labor productivity did not differ greatly from that of other Latin American countries. The TFP outlook for Mexico is more discouraging. According to the INEGI (2013), the TFP annual variation rate averaged -0.39% between 1991 and 2011. More specifically, the TFP of the primary sector fell during the same period by an average annual rate of 0.39%, whereas the secondary and tertiary sectors recorded an average annual decrease of 0.35% and 0.61% respectively. Graph 4 shows that the United Kingdom, United States and France, for instance, predominantly recorded positive TFP growth over the 1991-2007 period. Mexico, on the other hand, endured a number of major falls in productivity (1995, 2001 and 2009).

Graph 4. International trends in economic growth and productivity MExico

5% 0%

UNITED KINGDOM

-5% 5% 0% -5%

JAPAN

5% 0%

FRANCE

UNITED STATES

-5% 5% 0% -5% 5% 0% -5%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

TFP

2001 2002 2003 2004 2005 2006 2007 2008 2009

ANNUAL GROWTH IN GDP

Source: compiled privately based on data from INEGI, 2013, and EU KLEMS (http://www.euklems.net).

18


2010

The document recently published by the INEGI entitled Total Factor Productivity 1991-2011 calculates the contribution of this and other factors in terms of economic growth. In this respect, Graph 5 shows the annual growth rate of Mexican GDP over three different periods and the contribution of investment in physical capital, energy, materials, services, labor, and TFP in terms of GDP. As we can see, capital investment accounts for a significant proportion of the economic growth over the three periods, supporting the hypothesis that DIIAF can generate greater economic growth by promoting investment in fixed assets. However, TFP was negative over the three periods, meaning that its contribution to economic growth was virtually nonexistent, unlike in other countries. If we therefore improve efficiency in production processes, we can boost GDP growth.

Graph 5. Low productivity inhibits the growth of GDP GDP GROWTH (%PER ANNUM)

In the graph displayed above, we can see that a positive relationship exists between productivity and economic growth, thus confirming that productivity is a determining factor in the latter. Graph 4 also shows that in most of the countries analyzed, productivity began to decline in 20072008 and remained negative in 2009. Likewise, the 2009 financial crisis affected economic growth during the year, which was negative for all countries shown in the graph. In Mexico in particular, 2009 was when the lowest growth figure over the entire period analyzed was recorded. By contrast, in 2010, the country recorded its largest growth in TFP and Gross Domestic Product (GDP).

4 3 2

Capital energY

1

materialS servicEs

0

LABOR TFP

1994•2002

1998•2002

2003•2011

Source: compiled privately based on INEGI, 2013.

Hanson (2010) writes that the low productivity of the Mexican economy is due to shortcomings in the loans market and distortions caused by the informal economy. According to Pagés (2010), most enterprises in Mexico are small and largely unproductive due to the lack of accessible loans and the inefficiency of the financial markets, leaving many firms under-served and limiting investment and growth opportunities. Public and private underinvestment in research and development has also helped to cause the weak growth in productivity during recent decades. It is worth noting that Mexico is the country in the OECD with the lowest levels of public investment in research and development as a percentage of GDP. Given the importance of enterprise productivity in terms of competitiveness, and following the analysis of Mexico’s performance in the subject, a labor reform was passed in the transition period between the departure of Felipe Calderón’s


19

administration and the arrival of Enrique Peña Nieto. One of the highlights of this reform is the obligation on the part of business leaders to train their employees, in the interests of increasing productivity. Another of the amendments to the Federal Labor Law has led to the creation of the National Productivity Committee, which is composed of federal government members and representatives of business organizations, trade unions, and academic and educational institutions. This committee’s powers include: proposing productivity and employment strategies, policies, and actions; leading a national assessment of the requirements necessary to increase productivity; producing recommendations for qualifications and training plans and programs, and; issuing opinions on the allocation and application of budgetary resources targeted at increasing productivity (SHCP, 2013b). Furthermore, the current government has made “democratizing productivity” one of the three cross-cutting strategies of its 2013-2018 National Development Plan, which means the nationwide provision of development and opportunities which enable companies, sectors, and regions to make efficient use of their resources and achieve their full potential. To achieve this objective, the federal government will: • Encourage the productive resources of the Mexican economy to be made more efficient, which involves shrinking the informal economy and raising levels of financing. • Strengthen the business environment, which means encouraging economic competition and pursuing an effective tax policy. 20


• Establish conditions which enable increased business productivity, bringing greater investment in human capital. • Design a regional and sectoral productive development policy, which includes the adoption of a sectoral promotion policy, increased infrastructural investment, and the boosting of foreign trade (SHCP, 2013a). Although the proposed actions are important in raising the country’s level of productivity, mechanisms must be put in place that allow these to be materialized. For instance, the concrete productivity goals that must be achieved by 2018 under the 2013-2018 National Development Plan are yet to be defined. Although the National Productivity Committee has the power to draft measures and public policies that impact national productivity, its recommendations are not binding and their implementation is subject to the political will of each government department.

The promotion of business productivity is essential, since it has positive effects on competitiveness and economic growth and can lead to improvements in employment, salaries, and social wellbeing. Accordingly, increases in production inputs (the labor force and capital) can generate short-to-medium term growth.7 However, to achieve sustained economic growth, improvements in TFP are also necessary.

7 For further detail, see Solow, 1956. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

21

INFOGRAPHIC 1.

HOW TO PROMOTE INVESTMENT IN MEXICO? Tax expenditures, when designed correctly, can promote productive investment.

WHAT IS A TAX EXPENDITURE? A tax grant given by the government to enterprises or individuals to:

Promote

boost

create

improve

Encourage

productivity

strategic sectors

jobs

income distribution

use of clean energies

ADVANTAGES

DISADVANTAGES

(if well designed, they...)

(if not designed properly, they...)

• Generate comparative advantage • Improve business environment • Boost investment in areas with little development • Encourage the attraction of capital • More investment could generate more tax collection

Recommendation:

• Complicate tax administration • Are not transparent • Are inequitable • Finance unprofitable projects • Create incentive wars

With an intelligent design, tax incentives for investment promote productivity in Mexico.

CHAPTER 3.

The Role of the Tax System in Promoting Investment and Productivity Tax policy can be a powerful instrument for promoting macroeconomic stability, employment, productivity, competitiveness, and economic growth, as well as being the mechanism for the collection of revenue and forming public expenditure policies (Agostini & Jorratt, 2013). In terms of productivity, the tax system can be used to increase the efficiency of factors of production. In particular, one of the recurring practices aimed at increasing company productivity is the boosting of investment. Hence the importance of studying in greater detail the different avenues through which the tax system can promote this. First of all, tax systems have a number of desirable attributes, among which feature transparency, simplicity, fairness, stability, and efficiency. As long as countries enact reforms that enable these to coincide with international recommendations or best practices, there will be major incentives for investment. On this basis, the WB, the International Monetary Fund, and the OECD maintain that “tax system design is closely linked to domestic and international investment decisions” (2011, p. 8). There are numerous cases of tax systems whose features have negative effects on investment. In Colombia, for instance, the instability and complexity of its tax policies are two of the main problems the tax system faces in boosting investment (Cárdenas & MercerBalckman, 2005).


23

BOX 3.

Administrative Simplification in Mexico The simplicity of a tax system can be observed in three areas or stages: 1) tax policy, 2) tax legislation, and 3) tax administration. The first step in designing a tax system is to define its tax policy; in other words, to decide fiscal measures and the segments that will be taxed and exempt from taxation. From this point onwards, complexity can be added to the tax system by imposing a number of different taxes or by granting tax exemptions. Subsequently, the design of tax policy must be passed into law efficiently, and so tax legislation must be explicit, straightforward, and precise in order to meet the tax policy’s objectives. Finally, tax administration allows the creation of an administration and oversight system that will execute these tax laws. The creation of regulations, processes, and procedures that tax administration requires for the above to be achieved can add further complexity to the tax system (Ibarra, 2006). According to the Income Tax Law presented by the Executive to the Legislative Branch in September 2013, The structure of the Mexican tax system is at times complex and burdensome. This complexity causes taxpayers to allocate greater human and financial resources to the fulfillment of their tax obligations than in other tax systems. From the perspective of the tax authority, this situation also hinders the exercise of their powers, including that of ensuring that taxpayers duly fulfill their tax obligations (SHCP, 2013, p. I). In view of the above, the 2014 Social and Tax Reform proposal included measures to simplify the three aspects mentioned above. In terms of simplifying tax policy, the tax reform proposed to abolish 77% of preference schemes and 47% of special treatments, to abolish the Flat-Rate Business Tax (IETU) and the Cash Deposit Tax (IDE), and to standardize the rates of Value Added Tax. Regarding the simplification of tax legislation, a reduction in the number of articles of the Income Tax Law from 238 to 193 was approved, with the aim of making this form of taxation more straightforward. However, the bulk of the amendments proposed under the tax reform are intended to simplify tax administration. In fact, some of the proposals aim to streamline the functions of the tax authority, while others are designed to simplify the fulfillment of taxpayer obligations.

24


As for the tax authority, the simplification proposals aim to make the control and auditing processes more efficient, particularly in terms of providing more and better taxpayer information. The specific measures proposed are:

• Online accounting on IT systems. • Repeal of the measure obliging taxpayers to have their financial accounts signed off on by an authorized public accountant.

• Tax residence will be linked to the taxpayer’s bank details.

• Tax return requests and notices will be sent digitally by the tax authority.

• To open a bank account, a party must be registered with the Federal Taxpayers’ Registry.

With some minor changes, all of the above proposals were approved by the Chamber of Deputies. Although the above mentioned actions represent significant progress in terms of simplifying tax payments, best international practices and recommendations show us further areas of opportunity for Mexico. In fact, the simplification of tax policy and legislation can contribute to creating a competitive tax system.

• Information will be requested from financial organizations and savings and loan cooperatives, so that taxpayer information is kept updated. • The use of digital tax receipts will be mandatory. In terms of the impact this simplification has on the taxpayer, the Social and Tax Reform includes: • The option to obtain an Advanced Electronic Signature through an attorney-in-fact or legal representative. • A taxpayer’s mailbox so that the tax authority can send digital notices and requests, and receive documents and information from the taxpayer.


25

Secondly, a tax system helps to promote investment by collecting the revenue necessary for strategic sector investment. According to the OECD (2005), the tax system contributes to or limits the financing of public expenditure, and given that investment levels also depend on the infrastructure a country has available, the skills of its workforce, or other aspects that require government expenditures, tax revenue plays a key role in investment. Thirdly, as far as organizations such as the OECD (2005) are concerned, tax rates directly impact levels of investment, since they determine the net benefits that enterprises can obtain, in the sense that a high tax burden has a negative impact on investment. Accordingly, some studies and indices, such as Tax Competitiveness of the Maquiladora Industry: a Study from the International Perspective (KPMG, 2012), and the 2013-2014 GCI suggest that Mexican tax rates are a barrier to competitiveness. Finally, another one of the tools that governments commonly use to create a conducive investment climate is tax expenditures. In theory, tax expenditures promote investment, as enterprises can reduce, avoid, or defer their tax payments. Since tax expenditures are the subject of this study, their relationship with investment will be developed in the following section.

3. 1. SUPPORTING ENTERPRISES: TAX EXPENDITURES Technically, tax expenditures in Mexico are defined as preferential treatments resulting from the application of strategies that vary from normal tax structures. In other words, they differ greatly from the original design of taxation, which is generally applied to all taxpayers. In simple terms, tax expenditures are concessions granted to individuals

26


or enterprises to achieve different objectives.8 These tax regimes involve a cost to governments, as they result in a tax revenue loss due to the fact that certain taxpayers (individuals or corporations) are not subject to the general provisions of tax laws.9 It is worth noting that several types of preferential treatment exist internationally, including fiscal stimuli, tax exemptions, differentiated rates, administrative incentives, tax subsidies and credits, authorized deductions, tax relief and special tax treatments and regimes provided under the various tax laws. One objective that can be achieved using tax expenditures is the promotion of private investment. Artana (2012) writes that incentives that reduce the purchase cost of some inputs have a direct impact on investment, since they improve the net sale price received by the enterprise. Hubbard & Hasset (1996) carried out a study in the United States on the effects of the tax system on fixed capital investment. Among other aspects, the outcomes show that, with an increase in tax incentives, capital costs are reduced, thus encouraging companies to make investment expenditures in this type of asset. In a climate where there is greater competition to attract investment, countries make use of all available tools to create a conducive business environment. In this respect, some governments opt to use tax expenditures. However, caution must be taken in granting tax expenditures for the purposes of promoting investment, since employing this tool brings certain advantages and disadvantages, which must be assessed before they are implemented (see Box 4).

8 These objectives can include promoting productivity, driving certain sectors of the economy, job creation, improving income distribution, encouraging green energy use, etc. 9 As we will see later on, in addition to this revenue loss, the use of tax expenditures can also have negative implications, such as tax evasion. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

27

BOX 4.

Advantages and Disadvantages of Using tax Expenditures to Encourage Investment Advantages • They improve the skills of the workforce and encourage job creation. • They allow reactions against comparative advantages caused by tax reductions or preferential treatments offered in other countries. • They compensate for a number of shortcomings in the investment climate (Artana, 2012). • They are a practical and flexible tool for attracting investment in underdeveloped sectors and regions. • They make it possible for investments to stay in the country, regardless of the movement of capital. • By increasing investment, they can generate greater tax revenues (James, 2009).

28


Disadvantages • Tax incentives for investment can prove redundant, since investment can occasionally materialize without them. • They represent a government cost (which takes the form of revenue loss), as well as being of limited transparency, thus facilitating evasion and avoidance, and complicating tax administration. • Under certain circumstances, they drive up tax rates to finance the revenue loss. • They can create distortions in the allocation of resources, as they alter investment options. • They are inequitable, as they often benefit higher-revenue taxpayers. • They provide “unfair” tax competition, given that not all enterprises in the country have access to them.

• Even where tax expenditures have a positive effect on investment, it is unclear whether this leads to greater economic growth, since lowproductivity projects can also be profitable (Artana, 2012). • The use of tax incentives to attract investment can lead to an incentive war between countries (Gligo, 2007). This competition to provide the most attractive incentives undermines the expected benefits and can

prove to benefit transnational companies to the detriment of the power of the State and the wellbeing of its citizens (Morisset, 2003). • Tax incentives can be abused by companies that act as buyers for other companies that do not qualify for the incentive (Zee, Stotsky, & Ley, 2002), or can encourage companies to start up and close down solely to obtain tax benefits (Bolnick, 2004).

On one side, there are those who argue that tax incentives do indeed encourage greater levels of investment. In a dataset of 40 Latin American, Caribbean, and some African countries, Klemm and Van Parys (2010) evaluate the effectiveness of tax incentives in attracting Foreign Direct Investment (FDI). The study concludes that, in Latin America and the Caribbean, the existence of low business rates and tax incentives have a positive impact on FDI. In a similar vein, Morisset (2003) argues that some governments, such as those of Ireland and Singapore, have successfully attracted FDI through targeted tax incentives. A second group of experts maintain that tax expenditures are not a determinant of investment, and that other conditions offered by the country (non-tax incentives) are more important. In 2002 the WB’s Multilateral Investment Guarantee Agency, supported by Deloitte & Touche, carried out a study on the objectives and factors influencing the investment decisions of 191 multinational companies from around the world. The outcomes show that the main factors that companies take into account when investing are: a stable socio-political climate, ease of doing business, and the quality and reliability of infrastructure and basic services. By contrast, the importance given by investors to taxation and tax incentives is low. Nevertheless, the study also underlines that, whereas other aspects may be influential in choosing zones of potential investment, a final decision over where to locate may be made as a result of tax incentives (Multilateral Investment Guarantee Agency, 2002).


29

A third group of experts then argue that tax expenditures are only effective when comparing similar economies. Villela & Barreix (2002) maintain that economic integration tends to develop more homogeneous regional markets and, as long as the non-tax incentives are also similar, tax expenditures become more important in decisions over where a company will locate. In fact, the impact of tax incentives can be up to four times greater when the investment decision is between regions, rather than different countries (Villela & Barreix, 2002). Gligo (2007) goes on to argue that, in terms of FDI, empirical evidence shows that, during the first phase of country selection, tax incentives are not important, with more emphasis given to the structural advantages of each nation. However, these incentives do play an important role during the final phase of the selection process when comparing economies with similar conditions. Research into tax expenditures and investment also highlights that if a country wants to be considered for receiving greater FDI flows, it must have basic structural conditions in place since without them, the effectiveness of tax expenditures on investment is practically zero. According to Gligo, “incentives alone, regardless of how generous, will not make countries with inadequate business environments or insufficient resource availability become substantially more competitive” (2007, p. 106). Similarly, Morisset & Pirnia (1999) argue that a generous tax policy does not compensate for other barriers being present in the business environment. For instance, Sub-Saharan Africa and some South American countries have offered companies investment incentives to locate to underdeveloped, costly, and largely unattractive 30


regions. This strategy has been unsuccessful in generating greater flows of investment to these areas. It is important to note that, in addition to their impact on the investment decisions of multinational companies, tax expenditures can also encourage domestic investment. Governments can incentivize the acquisition or consumption of certain goods or services by approving tax expenditures, which leads to a reduction in costs. In view of the above, Roca (2010) maintains that total cost of capital is the main determinant of investment levels. Consequently, a reduction of this cost by way of tax benefits, for instance, would lead to increased investment given its elasticity with the cost of capital. However, there are very few studies into the impact of tax expenditures on domestic investment, and we therefore cannot be in any way certain of its effectiveness. Evaluation of the effects of tax expenditures on investment is a key issue, given the ambiguous nature of their outcomes and the resulting difficulty in generalizing their effects. In this respect, although evaluation on a case-by-case basis may yield less representative results, we can gain a more detailed insight into its impact on investment (Bolnick, 2004).

So, in an effort to increase the literature on the impact of tax expenditures on domestic investment and the productivity of Mexican enterprises, we will evaluate one of the main incentives implemented by the Mexican government in recent years to achieve this: the Immediate Deduction of Fixed Asset Investments (DIIAF).

3.1.1. OVERVIEW OF THE IMMEDIATE DEDUCTION OF FIXED ASSET INVESTMENTS In Mexico, a series of policies have been designed to encourage investment and enhance the productivity of its firms, of which one of the most important has been the DIIAF. This tax expenditure dates back to 1987, when it was first introduced. However, it was repealed in 1998 on the basis that it had not been leveraged by the small and medium enterprises for which it had been created (Cruz, 2003). On the first of January, 2002, the DIIAF was reincorporated into Chapter VII “On tax stimuli” of the Income Tax Law. As illustrated in Image 2, the statement of reasons explaining why this tax incentive was restored shows that it was intended to promote job creation and economic growth, particularly in regions of the country outside the main metropolitan areas. Rather, it aimed to promote balanced regional development by boosting investment.


31

INVESTMENT

PROPOSAL

DEDUCTION PRESENT

EXERCISE MEASURE

AREAS

REQUIRE

VALUE BEST

DEDUCT JOBS OBSOLESCENCE LIFE INVESTMENTS

TAX

RE-INVESTMENT DEVELOPMENT

USEFUL

CREATION OPPORTUNITIES

INCENTIVE

ASSETS

HUNDRED INSTANT

TOTAL

LOWER

WELL

TIME

GROWTH TYPE

PROPOSES LACK

LAW

DIRECT

EACH GREATER DEFERRAL AMOUNT APPLICATION RENT

NEW

INFRAESTRUCTURE SYSTEM PRODUCTIVE METROPOLITAN

COUNTRY COMPANIES

Image 2. The DIIAF’s objective: to enhance economic growth by boosting investment

Source: compiled privately based on the original statement of reasons for the DIIAF (Federal Official Gazette, 2002).

Under the 2013 tax reform, this tax incentive was again repealed on the basis that “it had not proved an efficient form of supporting investment, in particular of small and medium enterprises, having instead been unjustifiably used to reduce the tax burden of taxpayers, in particular, of large-scale enterprises” (SHCP, 2013, p. 6).

32


Although some of the data shown by the federal government proves that the DIIAF had been underused and that the benefit was concentrated among large enterprises, decisions over the continuation, modification, or abolition of tax expenditures in Mexico have not generally been accompanied by robust research containing the necessary information to back them up.

In light of the above, this study sets out to provide a comprehensive analysis of the effects of the DIIAF. To achieve this purpose, we first need to know how this incentive was designed. In accordance with article 220 of the LISR, effective until 2013, those who could benefit from the DIIAF were corporations subject to the general tax regime and private individuals engaged in business and professional activities who had made new investments in fixed assets. Moreover, considering that the objective of the tax expenditure was to redistribute investment in the country, the above law also provided for companies located outside of the metropolitan areas of Mexico City, Guadalajara, and Monterrey, who were eligible for the DIIAF. However, companies situated in these areas that did not employ water-intensive production processes, that used green technology for their polluting emissions, and that had gained certification of the above from the Ministry of the Environment and Natural Resources were also eligible for the deduction. Given the high concentration of capital stock in the metropolitan zones of Mexico City, Guadalajara, and Monterrey, this public policy decision seemed to be in line with the objective of generating balanced regional development. According to Map 1, the states with the greatest concentration of fixed assets are Nuevo León and the State of Mexico, followed by Coahuila, the Federal District, Guanajuato, Jalisco, and Puebla. Outside of the states mentioned, there is generally a low concentration of fixed assets.

Map 1. A handful of states account for most of Mexico’s fixed capital stock

Coahuila

nuevo leON

GUANAJUATO

FIXED ASSET ESTATE

JALISCO

STATE OF MExico

FEDERAL DISTRICT puebla 1,341,800

200,023,451

Source: compiled privately based on data from Censo Económico 2009, INEGI.


33

The DIIAF could be employed during the financial year in which an investment was made, in which it started being used, or in the year thereafter.10 Although article 220 of the LISR established the maximum allowable deduction percentages for each asset type, a decree published in June 2003 in the Official Journal of the Federation stipulated higher deduction percentages, which were adjusted based on a new discount rate. Although many commodities considered as fixed assets could be deducted immediately, in accordance with the LISR and subsequent decrees, the following were not eligible for deduction: • buses, cargo trucks, tractors, and trailers, except when used for federal and public freight and passenger transportation; • aircrafts, except when used for crop spraying; • office equipment; • shield equipment for motor vehicles, and • individually non-identifiable fixed assets.

10 In simple terms, the deductible amount was calculated as follows: the cost of the asset, or initial investment, was multiplied by an inflation-indexed adjustment factor. The permitted depreciation percentage for each asset type was then applied to the adjusted initial investment. The above gives a value that enterprises could deduct in a single financial year for the investment made. When this asset was alienated, lost, or no longer useful, an additional percentage could be deducted, which was calculated by taking the initial investment adjusted as of the period in which the immediate tax deduction was made and multiplying this by the applicable percentage in accordance with article 221 of the LISR. It is worth mentioning that, by making use of the immediate deduction, taxpayers would undertake to keep a detailed record of all investments, as stipulated by the LISR. 34


BOX 5.

Immediate Deduction vs. Straight-Line Depreciation To illustrate how the DIIAF operated, it is worth comparing it to the straight-line method of investment depreciation. In simple terms, the straight-line method allows the total cost of an asset to be depreciated over a prolonged period of time, which is normally fixed based on its useful life, whereas immediate deduction allowed a significant percentage of the initial investment to be written off in the short term. For example, if a company made an investment in construction, then under the straight-line method, it could have depreciated 10% of the asset each year over a ten-year period. Instead, under the DIIAF, the company could have written off 74% of the asset in the short term (during the period in which the investment was made, when it was first used, or in the year thereafter). In accordance with the LISR, a further percentage could be written off when the asset was alienated, lost, or no longer useful. In this case, if we assume that the asset was sold ten years after the immediate deduction was employed, the company could have deducted a further 7.35% from the initial investment, adjusted to the date when the immediate deduction was employed.


35

In the years immediately following the DIIAF’s 2002 reincorporation into the LISR, extensive use of the incentive was observed (measured in terms of revenue loss generated). In fact, the largest revenue loss was recorded in 2004. Between 2006 and 2013, the use of this tax incentive was in decline (see Graph 6).

REVENUE LOSS (MILLIONS OF PESOS)

Graph 6. Evolution of the revenue loss generated by the DIIAF. 38,000 36,000 34,000 32,000 30,000 28,000

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: compiled privately based on information from the SHCP and the INEGI.

According to information from the 2013 Tax Expenditure Budget (PGF), the main sectors that made use of the DIIAF were manufacturing, retail trade, mass media,11 and real estate and personal property rental and intangibles (see Graph 7).

11 According to the 2013 North American Industry Classification System, the mass media sector is composed of the following subsectors: a) publication and software publishing, except internet, b) motion picture and video industry, and sound recording industry, c) radio and television broadcasting, except internet, d) internet publishing and broadcasting, e) other telecommunications; f) internet access providers, web search services and data processing services, and g) other information services. 36


Graph 7. Manufacturing and retail trade: the main users of the DIIAF

15%

29%

OTHER SECTORS

10% MASS MEDIA

MANUFACTURING

9%

REAL ESTATE, RENTAL AND LEASING

18%

8%

RETAIL TRADE

MINING

6%

CONSTRUCTION

4%

WHOLESALE TRADE

Source: compiled privately based on information from the 2013 PGF.

Given the revenue loss amounts generated by the DIIAF since it was created, we need to investigate its effects. In particular, it is important to assess whether this tax expenditure had the expected impact on business investment, productivity, and competitiveness.


37

INFOGRAPHIC 2.

AN INCENTIVE TO PROMOTE INVESTMENT WHAT was THE DIIAF? DIIAF

Tax grant given to individuals and enterprises to promote investment through an income tax deduction.

HOW WAS THE DIIAF DESIGNED? In Mexico, the DIIAF could be applied exclusively outside the main metropolitan areas.

In the rest of the world, other criteria apply:

GEOGRAPHICAL AREA

ASSET VALUE

COMPANY SIZE

ASSET TYPE

STRATEGIC SECTORS

Asset value

(Germany)

TARGETING EXAMPLES

Geographical area

Asset type

(United Kingdom)

(United States)

Company size (Australia)

Strategic sectors

(New Zealand)

Recommendation:

2014 Social and Tax Reform eliminated the DIIAF, leaving enterprises without incentives to directly promote investment.

Mexico needs a targeted tax incentive to promote competitiveness.

CHAPTER 4.

Why Invest in Fixed Assets? We can understand investment as the purchase of goods and services by economic agents in the interests of improving the production process of an enterprise. Investment is important because it is the most dynamic aggregate demand variable and, as a consequence, is largely responsible for fluctuations in Gross Domestic Product (GDP). It also plays a key role, together with population growth and technological progress, in increasing productivity and competitiveness and, consequently, economic growth. Although investment affects a number of variables, it has a particularly strong impact on productivity. It should be noted that several kinds of investment exist;12 however, investment in fixed assets has direct effects on the productivity of enterprises for two fundamental reasons. First, the accumulation of fixed capital allows for the expansion of a company’s production frontier; in other words, if increasing amounts of machinery and equipment are acquired each year, a larger quantity of goods will be produced, since more capital will be available for production. Second, over the passage of time, the fixed capital stock available to a company will become obsolete and will tend to depreciate. As such, greater levels of investment enable machinery and equipment whose performance is in decline to be replaced. In this way, companies maintain optimal levels of capital stock and levels of production. In both cases, if investment is aimed towards increasing capital stock or renewing existing fixed capital, this benefits business productivity. As a consequence, the DIIAF may have played an essential role, since its purpose was to incentivize the procurement of new machinery and equipment.

12 There are generally three kinds of investment made by companies: fixed investment (machinery and equipment), residential investment (buildings), and inventory investment (stock). TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

39

BOX 6.

Investment and Productivity in Mexico In Mexico, TFP and gross fixed investment (including both FDI and domestic investment) maintain a close relationship. In years where the latter increases, an increase in TFP is also recorded, despite changes in TFP not being as pronounced as those seen in investment. As shown in Graph 8, high levels of investment were recorded in 2004 and 2006, when TFP was also positive, although the largest increase in the latter was recorded in 2010.

Graph 8. Investment and TFP are almost always hand in hand

TFP (ANNUAL GROWTH RATE)

4 10 2 0

0 -2

-10 -4 -6

-20 2002

2003

2004

2005

2006

2007

TOTAL FACTOR PRODUCTIVITY

2008

2009

2010

INVESTMENT

Source: compiled privately based on information from the INEGI and the Mexican Central Bank.

40


2011

2012

INVESTMENT (ANNUAL GROWTH RATE)

20

6

The decision to purchase capital assets is generally based on expected costs and benefits, which depend on the institutional arrangement that an economy has in place. As such, there are greater investment incentives in some countries than in others. As part of this institutional arrangement, the tax system affects investment decisions, as it determines the performance expected from the acquisition of capital. Within this, one of the policies that define the net benefits of investment is tax expenditures. Internationally, there are several kinds of tax expenditures to promote investment. In particular, as observed in Image 3, it is common for governments to offer different forms of investment deduction13 as an incentive for companies to increase or replace their fixed-capital estates.

Image 3. Internationally, accelerated depreciation, and immediate deduction supplement straight-line depreciation14

braZil UNITED STATES

COLOMBIA

ACCELERATED DEPRECIATION P LVS

perU

VL

UNITED KINGDOM australia

austRia

NEW ZEALAND

GERMANY

IMMEDIATE DEDUCTION

TRA

SPAIN

aRGENTINA

CANADA ITALY

FRANCE

chile SWITZERLAND

EL SALVADOR

STRAIGHT-LINE DEPRECIATION

mExico

Source: produced privately.

13 We can separate the methods of tax deduction for investments into three broad categories based on the period of time in which they can be employed. Straight-line depreciation is where an asset’s useful life determines the number of years over which the investment will be deducted and the percentage of its value that will be deducted each year will be consistent until such time as this period is over. Accelerated depreciation allows the value of an investment to be deducted over a period shorter than the asset’s useful life, with higher percentages that decrease over time. Finally, immediate deduction, which we can consider as a special case of accelerated depreciation, allows the present value of an investment to be written off in a single period. 14 For more detail regarding the features of the deductions employed in each country, see Appendix 1. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

41

Image 3 also shows us that Mexico is one of the few countries that use straight-line depreciation as its only investment incentive. In contrast, European governments tend to offer another method of deduction alongside the straight-line method. The United States, our main trading partner and one of the countries that receives the most FDI globally, has three tax deduction

methods in place for investments. In fact, Latin American countries at a similar development stage to Mexico, such as Argentina, Chile, Brazil, and Colombia, employ both straight-line and accelerated depreciation.

use of immediate tax deductions for investments tends to be on a targeted basis. According to Image 4, In addition to the above, the international benchmark shows us that the

some governments only allow immediate deduction for certain asset types, such as those in relation to research and development, and renewable energy. Others establish ceilings for the amount of fixed assets that can be deducted. For example, in Austria, Germany, and France, these ceilings are 400, 410, and 500 euros respectively.

Image 4. Immediate deduction targeting in different countries

ASSET VALUE

COMPANY SIZE

australia

Source: produced privately. 42


NEW ZEALAND

UNITED STATES

australia

UNITED KINGDOM

FRANCE

austRia

ASSET TYPE

NEW ZEALAND

UNITED KINGDOM

UNITED STATES

ITALY

STRATEGIC SECTORS

NEW ZEALAND

GEOGRAPHICAL AREA

GERMANY

australia

UNITED KINGDOM

For a long time, Mexican entrepreneurs could make use of both singleline depreciation and immediate deduction for their investments. However, on the basis that the DIIAF had been underused and that it was mainly used by large companies, the incentive was repealed in 2013. The decision to repeal the DIIAF has left companies at a disadvantage, since no similar policy aims to promote investment in the country. Against this backdrop, it is worth our while to carry out a study that allows us to identify, at the very least, the following: What effect did the DIIAF have on business investment and productivity? Did the costs incurred by the government justify the benefits? Was its repeal the right decision when there is no similar alternative15 for promoting investment? What other policies could prove effective in boosting investment? Were mistakes made in the DIIAF’s design and implementation which limited its effectiveness? What changes could be made to the tax incentive to strengthen its impact?

15 Accelerated depreciation, for instance. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

43

INFOGRAPHIC 3.

BOOSTING LOCAL DEVELOPMENT THROUGH INVESTMENT INCENTIVES Besides the Federal Government, states grant their own investment incentives.

NON-TAX INCENTIVES

TAX INCENTIVES

Top 6 of the most common incentives: NUMBERS OF STATES

ISN reduction for job-creating companies Incentives for R&D in technology Temporary ISN exemption for newly created companies Reduction in Property and Commerce Fees Reduction of construction license fees Incentives for projects outside the metropolitan area

25 24 22 22 21 20

Tax expenditures are not the only investment incentive at the state-level.

REAL ESTATE AT PREFERENTIAL PRICES

InfrastructurE AND PUBLIC SERVICES

LOCAL VENDORS TIE-INS

FINANCING INVESTMENT STUDIES

Job training scholarships

INVESTMENT IN MACHINERY

WHAT STATES OFFER MORE TAX INCENTIVES?

Sonora 19 Nuevo Leon 17

Hidalgo 16

TAX EXPENDITURES

CONCLUSiOn:

SIMPLIFIED PAPERWORK

DIGITAL MEDIA PROMOTION

The competition for investment among states can create an excessive offer of incentives. This affects local public finances.

CHAPTER 5.

Boosting Local Development through Investment Incentives There are a number of attributes that companies take into consideration when deciding to locate in a certain place. On the one hand are aspects such as geographical location, regulatory framework, infrastructure, security, and the presence of university research centers, cost of labor, production costs, labor stability and the presence of clusters. On the other hand, inter-state competition to attract investment compels local governments to provide incentive packages based on the needs of the investor. An essential component of this incentive package are tax expenditures. Table 1 shows the states that granted most tax expenditures during 2013.16

Table 1. Sonora, Nuevo León, and Hidalgo are the states that offer most tax expenditures Ranking

State

Number of Tax Expenditures Awarded

Ranking

State


1

Sonora

19

8

Durango

13

2

Nuevo León

17

9

Aguascalientes

12

3

Hidalgo

16

10

Puebla

12

4

Yucatán

15

11

Sinaloa

12

5

Baja California

15

12

Jalisco

11

6

Chihuahua

14

13

Coahuila

11

7

Tlaxcala

13

14

Campeche

9

16 Source: http://mim.promexico.gob.mx/wb/mim/seleccion_de_indicadores. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

45

Ranking

State


Ranking


State

15

Nayarit

9

24

Morelos

6

16

Quintana Roo

9

25

Distrito Federal

6

17

Guanajuato

8

26

Chiapas

5

18

Guerrero

8

27

Tamaulipas

5

19

Veracruz

8

28

Michoacán

4

20

San Luis Potosí

8

29

Oaxaca

3

21

Tabasco

7

30

Zacatecas

2

22

Colima

6

31

Querétaro

1

23

State of Mexico

6

32

Baja California Sur

NA

Source: compiled privately based on 2013 data from ProMéxico. NA: Not Available.

Most notably, the tax expenditure most frequently awarded by states is the Payroll Tax (ISN) reduction for job-creating companies, followed by special incentives for research and development projects in technology, then the temporary ISN exemption for newly created companies (see Table 2.)

Table 2. The most common state tax expenditure is the ISN reduction for job-creating companies Ranking

Tax Expenditure

1

ISN reduction for job-creating companies

25

2

Special incentives for research and development projects in technology

24

3

Temporary ISN exemption for newly created companies

22

3

Reduction in Public Registry of Property and Commerce fees

22

4

Reduction of construction license issuance fees

21

5

Special incentives for projects outside the metropolitan area

20

Source: compiled privately based on 2013 data from ProMéxico.

46

Number of Granting States


In addition to the tax expenditures mentioned in Table 2, subnational governments also grant tax credits for the Tax on the Possession or Use of Used Motor Vehicles, Property Tax, or Real Estate Transfer Tax. Whereas, fees for services provided by the Public Property Register, land use and construction licenses, drinking water and drainage connections, real estate appraisals, transfer of ownership, registration and issuance of license plates, legalization stickers and vehicle registration cards, reviews of architectural plans, and public lighting are also offered to companies as tax credits. Finally, some states also award special incentives for projects outside the metropolitan area. In addition to tax expenditures, the incentive packages offered by governments to set themselves apart from other states include different kinds of policies, which largely depend on company size and investment amount. Some of the most common practices are shown in Image 5.

Image 5. Tax expenditures are not the only incentives for investment in states17

Construction, procurement, lease or sale of real estate at preferential prices for business setup.

Building of infrastructure and provision of public services to facilitate company operations.

Enterprise and local vendor tie-ins.

Facilities provided for bureaucratic procedures.

Incentives to supplement state tax expenditures

Cash incentives for carrying out specialized studies or hiring professional services.

Support for initial investment in machinery and equipment.

Award of training scholarships or financial support.

Use of digital media to promote the state’s offer of incentives.


17 For more information on the additional incentives offered by subnational governments in Mexico, see Appendix 2. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

47

As we can see, local governments have implemented a variety of policies to attract investment. However, tax expenditures can sometimes play a key role in the decisions of enterprises about where to locate. According to KPMG, Guanajuato has received significant flows of investment in recent years, mainly due to its available infrastructure and the tax incentives offered by the state (El Financiero, 2011). Although awarding incentive packages can lead to greater investment in a state, we must also consider the negative consequences of such a policy. Competition for investment between states can lead to disproportionate incentive awards, which can have a direct impact on local public finances. For instance, of the 1.38 billion pesos of funding requested by the Guanajuato state executive to invest during the 2013 financial year, 359 million pesos were allocated to the construction of an access road for the Celaya plant installed by Honda. A further 296 million pesos were also invested in incentives for enterprise (Pizano, 2013). Given that local public finances tend to have high debt levels, a high dependence on federal remittances, low tax revenue collection, and growing pressure on expenditure due to the diverse economic and social needs of the population, an in-depth analysis needs to be carried out of the costs and benefits of awarding incentive packages to companies.

48



49

INFOGRAPHIC 4.

TOWARDS A SMART TAX INCENTIVE The DIIAF, as it was designed, did not influence entrepreneurs’ investment decisions.

Ethos EVALUATED THE DIIAF AS:

IT WAS AN EXPENSIVE TAX INCENTIVE 2002 • 2013

Inefficient

Costly

During its entire existence, its costs exceeded its benefits.

306

55 TIMES

BILLION

1.5 TIMES

COST OF THE DIIAF

INVESTMENT IN HEALTH SECTOR INFRASTRUCTURE FOR 2013 INFRASTRUCTURE EXPENSES APPROVED IN THE PEF 2013

Costs Benefits

WHAT DO ENTREPRENEURS REQUIRE?

MORE FINANCING 63% rely on their own resources.

INVESTMENT

ProductiviTY

CompetitivENESS

15% stated the DIIAF encouraged the purchase of fixed assets.

Investment in fixed assets determines their productivity.

High tax rates are harmful.

1.

Ethos

recomMENDS: 50


2.

3.

A NEW TAX INCENTIVE:

EFFECTIVE promoTION OF:

• strategic sectors • productive assets • nationwide

• government support and credit

ADMINISTRATIVE SIMPLIFICATION

SMART INCENTIVES The DIIAF was used only in 11% of total investment.

4.

TAX EXPENDITURES EVALUATION

CHAPTER 6.

Immediate Deduction of Fixed Asset Investments and its Impact on Competitiveness In Mexico, the need to collect more tax revenue is reflected year after year in the approval of different measures, with accountability and transparency playing key roles. As mentioned in the previous chapters, tax expenditures, like direct spending, are public policy tools that aim to promote economic growth, create employment and increase productivity and competitiveness, among other objectives. However, in Mexico some of these policies do not have clear objectives and little is known about their effectiveness. The case of the DIIAF reflects the lack of transparency in tax expenditures, both in terms of the reasons behind their introduction and the outcomes produced. In fact, transparency has been lacking since the first time the DIIAF took effect. An example of this is the proposal for the DIIAF’s repeal, submitted in the Draft Decree in which the 2014 LISR was issued (SHCP). In this document, the Ministry of Finance and Public Credit (SHCP) set out arguments for its repeal, underlining: • The incentive’s ineffectiveness in promoting investment, since it only benefitted large companies. In fact, the SHCP reported that high-revenue companies accounted for 93% of the benefit’s uptake.


51

• The DIIAF facilitated tax avoidance by corporations with increasingly sophisticated accounting systems. The SHCP found that business groups would buy new companies that were in need of investment in order to defer the tax of the other companies in the group. • The incentive increased the concentration of firms. The practice mentioned in the above point resulted in a greater concentration of firms, in turn reducing the number of competitors, strengthening business groups, and inhibiting market competition.

take future scenarios into account when estimating their investment amounts (WB, 2009). The Mexican tax system can thus be considered unstable and incoherent in terms of its tax measures, which aim to encourage investment. Although the DIIAF had been operational in Mexico for little over ten years following its resumption in 2002, key information on its outcomes was still not known. Whereas the incentive’s objective was to lessen the government cost of investments by promoting the procurement of fixed assets for their use in the productive system, it is essential

Regardless of the above, the SHCP did not publish a detailed study on the incentive’s outcomes, and taxpayers did not have access to the data and statistics used to justify the decision made. Therefore, information on the effectiveness and efficiency of the DIIAF was scarce. This case highlights the discretion with which some decisions about changes to the Mexican tax system are made, which puts us at a distance from the best international public finance practices, which are based on the pillars of transparency, access to information, evaluation of outcomes and simplification, among others.

that we find out whether the DIIAF was effective in increasing business productivity and if this increase compensated for the revenue loss generated. Impact and cost-benefit evaluations are useful tools for finding out the effects and magnitudes of a public policy and they allow for the suggestion of the changes necessary to resolve the problems detected and for the leveraging of the strengths of the program evaluated, thereby contributing to greater achievement of its objectives. The outcomes of these assessments must be accessible and, as far as possible, information must be used in such a way that the outcomes obtained can

In October 2013, the Legislative Branch approved the repeal of the DIIAF on a similar basis to that used the first time it was done away with in 1998. In this respect, Mexican government policy on the use and disuse of the DIIAF, and the lack of clarity in justifying these measures, have an impact on the investment decisions of entrepreneurs. Uncertainty over the duration of tax system measures makes long-to-medium term strategic planning difficult for firms, as entrepreneurs try to 52


be replicated and corroborated. In turn, this encourages the efficient use of resources and effective public policy.

In the interests of determining whether tax incentives such as the DIIAF can prove suitable for promoting business investment, productivity and competitiveness, an evaluation methodology was developed to provide answers to the following questions:

Image 6. What will the impact assessment tell us?

Did the DIIAF produce the expected outcomes?

Were the resources used efficiently?

Could the design of the tax incentive have been improved?

Impact Assessment

To what extent did the DIIAF affect business investment and productivity?

Were entrepreneurs satisfied with the incentive?


6.1 ABOUT THE EVALUATION METHOD This study evaluates the DIIAF in terms of its efficiency and effectiveness (see Image 7). The incentive’s efficiency is measured through an analysis examining the relationship between its associated benefits and costs. Effectiveness is analyzed by way of an impact assessment that will show us whether the tax incentive boosted business investment in fixed assets and productivity. This second analysis employs statistical and econometric techniques, which will be supplemented by a qualitative analysis of information pertaining to entrepreneurs’ perceptions on the operability of the DIIAF. We will use this to examine the issues that limit the growth of productivity and business development in the country.


53

Image 7. Evaluation Methodology

Qualitative and quantitative data

• Statistical and economETRIC techniques • Entrepreneurs’ opinions

Quantitative data

Statistical techniques

impact ASSESSMENT (Effectiveness analysis)

EVALUATION Cost-benefiT EVALUATION (Efficiency analysis)


By combining quantitative and qualitative data in this evaluation, we are presented with significant advantages, since it makes it possible to supplement the analyses, validate their outcomes and add greater depth to the study. The above leads to a more complete understanding of the subject, and makes the results obtained more robust for the purposes of designing public policy recommendations.

6.2. RESULTS 6.2.1. EFFICIENCY OF THE IMMEDIATE DEDUCTION OF FIXED ASSET INVESTMENTS: THE COST OUTWEIGHS THE BENEFITS The task of finding out whether a program is worthwhile in terms of its cost to the government and the benefits and externalities that it produces is essential for evaluating whether it should be amended or repealed. Given that public resources are limited and expenditure needs are many and diverse, it is the government’s duty to allocate its resources efficiently to activities or projects that generate the greatest benefit to the economy and to society. As such, this kind of analysis allows us to measure the opportunity cost facing the country if it continues a certain program. If the profitability indicators of the cost-benefit analysis are negative, then the resources relinquished by the government or the costs that it incurs in continuing a program, policy, or project could be used in other, more profitable, activities.

54


With this methodology, ex-post evaluations are a common practice for determining whether a program that has been operating for a prolonged period has proved profitable over the years. In this document, we are carrying out this evaluation to determine the profitability of the DIIAF in the interests of gaining evaluation elements in relation to the aggregate costs and benefits that this incentive produced on a national level. To carry out this analysis, an evaluation period is determined; then, the costs, benefits, and externalities associated with the program’s deployment are identified and quantified, when possible. Finally, the net benefits and the profitability indicator are obtained. To assess whether the DIIAF’s deployment was profitable, we will consider the period between and including 2003 and 2012. In 2003, the SHCP first recorded a revenue loss from this tax expenditure in the PGF. For the purposes of this analysis, the cost of the tax expenditure will be considered as the revenue loss generated by the DIIAF’s implementation. This cost is merely an approximation of the revenue that could have been collected if this tax expenditure had not been in force. Given that changes in taxpayer behavior that may have occurred as a result of the preferential treatment’s repeal are not taken into account, revenue loss is approximate. In this analysis, benefits are calculated in monetary terms and show the extent to which production increased as a consequence of investment through the DIIAF. This estimate uses data from the System of National Accounts of Mexico (SCNM) and considers the contribution of fixed-capital

investment to total production.18 Due to the lack of information on the total amount invested through the DIIAF, this figure was estimated based on three scenarios. The first scenario contemplates an adjustment factor of 18%, which is the percentage deduction for investments using the DIIAF, in accordance with the statement of reasons of the 2014 Social and Tax Reform proposed by the SHCP. The second scenario follows the same logic, but this time takes its lead from the information contained in the Business Competitiveness Survey designed by Ethos, which reveals that, of the total invested by entrepreneurs over a set period, only 11% was deducted using the DIIAF. As such, the data on private sector levels of Gross Fixed Capital Formation reported by Banco de México was weighted to the 11% reported in the Survey. The third scenario estimates the amount invested based on the revenue loss generated by the use of the DIIAF. The contribution of each of the three estimates of DIIAF-associated investment to economic growth is then calculated. It is worth noting that the estimation of benefits does not take into account all indirect effects or externalities that lead to greater investment in fixed assets, such as the driving of technological progress and innovation development in the associated industry or sector; improved productive conditions in the

18 The contribution of fixed-capital investment to total production is calculated based on the KLEMS total factor productivity measurement model used by the INEGI, which considers the capital (K), labor (L), energy (E), materials (M), and service (S) inputs in the country’s production function.


55

geographical region; increased investment in fixed assets by competitors; higher wages and improved working conditions of the investing company. The above is due to a lack of data, and the fact that the precise measurement and estimation of these effects on the Mexican economy as a whole goes beyond the scope of this project. Nevertheless, an approximation has been made of the externalities that investment in fixed assets, using the incentive, has on production during the periods following this investment. In this particular case, and in accordance with some studies carried out by Banco de México,19 it is estimated that investment in fixed assets has a positive effect on production levels, the impact of which can still be felt four years after this investment was made. As we can see in Graph 9, for each of the three scenarios shown, negative figures were always recorded for the net value of investment in fixed assets over the period in which the DIIAF was in force. These results clearly show that DIIAF was not a profitable incentive, at least in terms of how it was designed prior to its repeal. However, it is worth underlining some considerations in this regard. The first is the development of costs and benefits. An upward trend is recorded in the latter, from 2003 up to the 2008 financial crisis, demonstrating the deferred, long-term effect of investment in fixed assets. Secondly, the cost of

rising as a result over the period. Using the costs and benefits estimation, the net present value of the DIIAF is calculated for the 2003-2012 period by applying a 12% deduction rate.20 Calculating the net present value for the most positive scenario produced a negative of approximately 104 billion pesos. Thus, in view of the assumptions used to develop this cost-benefit analysis, the DIIAF

was not profitable for the country in aggregate terms. As such, we can argue that, due to its features and how it operated during its effective period, the DIIAF was costly and inefficient. This outcome leads to the following questions: What government policy alternatives could prove more effective in promoting investment and productivity? And what investment projects could have been funded using these resources? To answer these questions and size up the opportunity cost to the government in continuing an instrument such as the DIIAF, we can contrast the revenue loss generated by the government incentive with other, more efficient, options related to factors that directly impact on business productivity. Box 7 shows the hypothetical expenditures that the government could have financed using the resources allocated to the DIIAF.

the DIIAF shows a downward trend over the same period. This caused the gap between costs and benefits to narrow, with the net value of the DIIAF

19 (Chiquiar, 2009; Cuadra, 2008; Antón, 2008; Pérez López, 2004; Sánchez, 2001) 56


20 This deduction rate was applied because it is the rate used by federal government to evaluate its production projects.

Graph 9. A decade of DIIAF non-profitability

$0

NET VALUE (THOUSANDS OF PESOS)

$-5,000,000 $-10,000,000 $-15,000,000 $-20,000,000 $-25,000,000 $-30,000,000 $-35,000,000

2003

2004

2005

2006

COST-BENEFIT ANALYSIS:

2007

2008

scenario 1

2009

2010

scenario 2

2011

2012

scenario 3

COST-BENEFIT ANALYSIS (thousands of pesos) 2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

PerIod

$ 31,457,908

$ 39,312,716

$ 34,264,150

$ 29,937,910

$ 30,329,704

$ 27,410,585

$ 28,055,275

$ 29,397,237

$ 29,192,627

$ 27,233,000

Costs

$ 3,559,433

$ 7,361,701

$ 11,997,895

$ 19,574,381

$ 23,647,728

$ 25,212,805

$ 24,826,185

$ 22,292,279

$ 20,513,166

$ 19,058,286

Benefits

-$ 27,898,474

-$ 31,951,015

-$ 22,266,255

-$ 10,363,529

-$ 6,681,975

-$ 2,197,781

-$ 3,229,090

-$ 7,104,959

-$ 8,679,461

-$ 8,174,714

Net Value

$ 2,175,209

$ 4,498,817

$ 7,332,047

$ 11, 962,121

$ 14,451,389

$ 17,463,183

$ 16,918,611

$ 15,108,055

$ 13,798,070

$ 12,719,640

Benefits

-$ 29,282,698

-$ 34,813,899

-$ 26,932,103

-$ 17,975,788

-$ 15,878,314

-$ 9,947,402

-$ 11,136,664

-$ 14,289,182

-$ 15,394,557

-$ 14, 513,360

Net Value

scenario 1 scenario 2 scenario 3 $ 1,474,977

$ 3,453,260

$ 5,405,854

$ 7,960,013

$ 9,063,265

$ 9,345,386

$ 9,354,919

$ 8,407,825

$ 7,744,667

$ 7,267,395

Benefits

-$ 29,982,931

-$ 35,859,457

-$ 28,858,296

-$ 21,977,896

-$ 21,266,439

-$ 18,065,199

-$ 18,700,356

-$ 20,989,413

-$ 21,447,961

-$ 19,965,605

Net Value

Source: compiled privately based on data from the INEGI and SHCP. N.B. For further details on estimation, see Appendix 3.


57

BOX 7.

Opportunity Cost of the DIIAF If we compare the expenditure decisions about infrastructure which, by law, have been analyzed and deemed profitable,21 we find that the total approximate cost of the DIIAF (a little over 306 billion pesos from 2003 to 2012) is equal to: • 55 times the amount invested in health sector infrastructure in 2013, which includes the building of clinics, hospitals and labs, the renewal of medical equipment, and the upgrade of specialized treatment units. • 1.5 times the total amount allocated to 1,049 infrastructural projects approved in the 2013 Federal Expenditures Budget (PEF), which include the construction and optimization of highways, roads, bridges and rural access roads and upgrade of seaports, airport equipment, etc.

Graph 10. What could have been done without the DIIAF

OPPORTUNITY COST

$5,574 MDP HEALTH SECTOR INFRASTRUCTURE (2013)

$3,240 BENEFIT OF THE diIaf (2003-2013)

$204,394 MILLIONS OF PESOS TRANSPORT AND COMMUNICATIONS INFRASTRUCTURE (2013)

$306,591MILLIONS OF PESOS cost OF THE DIIAF (2003-2013)

Source: compiled privately based on data from the 2013 PEF and the 2013 PGF. N.B. Data corresponds to the revenue loss associated with the DIIAF over the 2003-2013 period.

21 Specificaly in Tome VII of the 2013 PEF, on infrastructural investment programs. 58


If we realize that the government has limited resources and that it must make its expenditure decisions more efficiently, then it is essential that the design of government incentives and tax policy in general, should take into account the opportunity costs of its decisions and strategies based on evaluations and estimates that lead to better decision making in terms of measures aimed at having an impact on the country’s economic development.

6.2.2. ON THE INEFFECTIVENESS OF THE IMMEDIATE DEDUCTION OF FIXED ASSET INVESTMENTS In theory, tax incentives can be a useful way to promote certain business activities. In practice, however, this depends on the design, geographical scope, simplicity of access, knowledge of how they work and other aspects. With this in mind, the key question is: did the DIIAF prove effective in promoting the investment, productivity, and competitiveness of companies in Mexico? To answer this question, we must first perform an effectiveness evaluation.

6.2.2.1. THE BUSINESS COMPETITIVENESS SURVEY In Mexico, information related to the use and deployment of the DIIAF by companies is not in the public domain and is protected by the Tax Administration Service (SAT). As such, to obtain reliable data and to carry out an effectiveness evaluation, it was necessary to conduct a Business Competitiveness Survey (hereinafter the Survey) with a nationally representative sample of companies. The incentive’s impact was measured in terms of the level of investment and productivity of companies, and using information that reflects the entrepreneurs’ perceptions of these. The Survey was made nationally representative with regard to the number of large companies registered in the National Statistical Directory of Economic Units that were incorporated before 2004 and belong to the mining, wholesale trade, retail trade, manufacturing, real estate, services, and information sectors. 22

22 Only these seven sectors were considered because, according to the 2013 PGF, they are the sectors that use the incentive the most. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

59

The sample used contains 445 large companies,23 representing a total of 7,005.24 The decision to select large companies for the universal sample was made based on experiences in the international field,25 which have found that they are the main users and beneficiaries of the kind of incentives under study, largely due to their design and tax system complexities. It is worth noting that the same argument was made by the SHCP to repeal the DIIAF in the 2014 Economic Package.

6.2.2.2. AN OVERVIEW OF LARGE COMPANIES IN MEXICO Business activity is essential for the country’s economic development. Large companies play an important role in this due to their size, level of production, consumer presence and performance. Although only 2% of all companies in Mexico are large companies, they account for approximately 48% of GDP and generate 28% of employment in the country (Ministry of Economy, 2013). As such, it is essential that we understand the strategic behavior that they have adopted to improve their productivity and competitiveness. With regard to spatial distribution, the Survey indicates that large companies are concentrated in the northern and central regions of the country, particularly in the states of Chihuahua, Coahuila, Baja California, Nuevo León, and the Federal District. In Map 2, we can observe that Chihuahua has the greatest concentration of large companies in the country.

23 Large companies contained in the INEGI’s 2013 National Statistical Directory of Economic Units were surveyed. The INEGI’s classification of large-scale companies states that a large manufacturing company will have at least 250 employees, whereas large services companies will have at least 100. 24 The stratified random sampling method was used. For more details on sampling methodology, see Appendix 3. 25 (James, 2009; Klemm & Van Parys, 2010; Biggs, 2007) 60


Map 2. Large companies are concentrated in the northern and central regions of the country

Baja california

Chihuahua Coahuila

nuevo leON

LARGE COMPANIES

14.0

995.0

federal DISTRICT

EMPLOYEES NOT AVAILABLE*

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. *No data available for the State of Hidalgo.

Large companies have been operating for an average of twenty one years, although it is noteworthy that almost 60% of them were created less than twenty years ago. The average number of workers employed by these companies is 265. However, the number of workers employed by large companies is mainly found to be within the 100-200 range, and the number of companies with more than 400 employees is minimal.

The results of the Survey do not present any evidence that older companies, or companies with more employees, are more productive. However, we do see that

older companies have more branches or plants distributed across different locations of the country, or rather, companies that have been operating for longer have been able to expand their markets to other regions of the country. Moreover, as we see Image 8, only 23% of large Mexican companies are exporters and only 13% have some share of foreign capital. Organizations such as the OECD and the European Commission quote internationalization as an important factor in business survival, development and competitiveness.


61

Image 8. Overview of large companies in Mexico

M bet ost c wee om n 1 pa 00 n an

y s plo rker m o e w ies 200 d

Average age 22 years

Average size 265 workers

EXPOR

T CO

IE S AN O M P AN N TH

23% ARE EXPORTERS

A N-E R E M XP ORE OR TER PR O D U CTI S.

VE

r pr e of od fo r uc ei g t iv n ca e pi ta l

LARGE COMPANIES

s 20 year than ars ess han 10 ye rl fo ss t ng or le gf

60% ha ve b ee 15% hav e bee n ope r n op era ati tin

13% HAVE SOME SHARE OF FOREIGN CAPITAL

Compa

n

a sh e a r h wi t mo ie s a r e

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

As described in Graph 11 export companies are, on average, more productive than non-exporters.

62


Graph 11. Export companies are more productive

PRODUCTIVITY 550

550

500

500

TURNOVER/WORKERS

400

514.160

518.420

450 400

350

350

300

300

250

250

200

200

150 100

220.05

208.29

50 0

150

TURNOVER/MAN-HOURS

450

100 50

EXPORTER

PRODUCTIVITY MEASURED BY:

noN- exportER TURNOVER/WORKERS

0

TURNOVER/MAN-HOURS

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. N.B. Retail and wholesale trade sectors are not included.

Additionally, the Survey reveals that large

companies with a share of foreign capital have a level of productivity that is above the national average. This underlines the importance of FDI in business productivity, since it enables the input of new technologies, processes and standards (Fujii, 2004).

The sectors where large companies are prevalent are wholesale trade and manufacturing, accounting for 35% and 32% of these sectors, respectively. In commercial and legal terms, large companies are mainly incorporated under the sociedad de capital variable regime (50%), followed by sociedad anónima (42%). The average values for total gross turnover, operating costs, total wages and salaries, total sales, capital stock, and fixed-asset investment by number of workers during 2012 are shown in Table 3.


63

Table 3. The greater the size, the greater the performance Number of Workers Variable

100 to 199

200 to 299

300 to 399

More than 400

Total wages and salaries Total fixed assets Total gross turnover Total sales/production Total investment in fixed assets Total operating costs

38.18

57.38

40.17

34.31

27.10

40.90

43.22

82.63

99.34

138.97

163.42

189.67

108.44

124.24

96.55

200.48

7.84

9.82

6.51

18.11

25.86

39.18

37.17

43.06

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. N.B. Data in millions of pesos for 2012.

Table 3 emphasizes that, for companies with more workers, investment in fixed assets and capital stock are much greater than for other variables as the number of workers increases. The geographical distribution of labor productivity shows that there is a higher concentration of

highly productive companies in the north and center of the country, particularly in the states of Chihuahua, Coahuila, Federal District, Guanajuato and Nuevo León (see Map 3). However, geographical distribution in terms of amount invested during 2012 does not follow the same localization patterns as those we have seen for the labor productivity variable, since only some isolated points in the center and northeast of the country, such as the Federal District and Nuevo León, also score well for this variable, whereas in the rest of the country, the level of investment is relatively even and low. We can therefore deduce that, other than in the Federal District

and Nuevo León, there is no clear correlation between labor productivity and investment in fixed assets, since there is no pronounced pattern between amounts invested and levels of productivity.

64


Map 3. The central and northern regions of the country are niches of productive companies

Chihuahua Coahuila

nuevo leON

GUANAJUATO

LABOR PRODUCTIVITY federal DISTRICT

9

31,322 NOT AVAILABLE*

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. *No data available for the State of Hidalgo.

6.2.2.3. EFFECTIVENESS ANALYSIS One of the most commonly used and accepted methods for carrying out an effectiveness evaluation is to compare the average differences in the variables under study between a control group (non-beneficiaries) and a treatment group (beneficiaries). Different techniques exist to develop this type of evaluation, the foremost of which is Propensity Score Matching (PSM).26 This method reveals the effects of the program, in this case the government’s incentive, by estimating what would have happened if its users had not made use of the assistance or program (counterfactual scenario).

26 Further details over the collection of information, sample design and each of the techniques, alongside their specific results, can be found in Appendix 3 of this study. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

65

Image 9. Display of an impact assessment intervenTION

PRIMARY OUTCOME

impact COUNTERFACTUAL

TIME Source: Compiled privately.

PSM involves the creation of a control group that is as similar to the treatment group as possible, to ensure that any difference that may exist between the impact variable averages of the groups is exclusively a consequence of them using the program. For the DIIAF in particular, the control group is created by selecting observable company characteristics, such as company age, type of business entity, size, sector and operating region. Then, the average of the impact variables is calculated for the control and treatment groups and it is determined whether the difference between these results is statistically significant. Data obtained in the Survey were used in this analysis. Table 4 shows the values for the variables selected to create the control and treatment groups. The composition of the groups was such that both were balanced from the sample’s design. Given the high rate of “no answers” reported, particularly for impact variables (amount invested in fixed assets and total wages and salaries, to get the labor productivity) the sample actually used was reduced to 364 companies, of which 210 were in the control group and 154 (42%) were in the treatment group.

66


Similarity between the control group and the treatment group is important for carrying out an effectiveness evaluation, since greater similarity in terms of their observable characteristics will lead the effectiveness evaluation to produce more accurate results. As shown in Table 4, the companies in the control and treatment groups have very similar characteristics. The average number of workers employed by the companies is 226 and 265 for the control and treatment groups respectively. Average age is approximately twenty two years for the total sample and for each group. The companies are generally in the manufacturing, retail trade and wholesale trade sectors. Most of the companies surveyed are concentrated in the northern region in both the control and treatment group. Finally, the types of business entity are predominantly sociedad anónima and sociedad de capital variable. However, there are some areas where the balance is not ideal, particularly in terms of sector and type of business entity.

Table 4. Overview of companies surveyed Variable

Total

Control

Treatment

364

210 (57.69%)

154 (42.31%)

242.47

226.13

264.90

22.15

21.89

22.51

Mining

0.82

0.48

1.30

Construction

4.67

6.19

2.60

Manufacturing

35.44

31.43

40.91

Wholesale trade

35.44

33.33

38.31

Retail Trade

18.68

21.43

14.94

Mass Media

1.65

1.43

1.95

Real estate and lease services

3.30

5.71

0.00

North

40.93

40.00

42.21

North-Central

21.43

24.76

16.88

Central

24.45

21.43

28.57

South

13.19

13.81

12.34

43.68

48.57

37.01

Number of companies Average workers Average age (years) Economic sector

Region

Type of business entity Sociedad anónima


67

Variable Sociedad de capital variable

Other Investment in fixed assets (millions of pesos) Labor productivity (millions of pesos)

TFP

Total

Control

Treatment

48.90

43.33

56.49

7.42

8.10

6.50

9.54

8.18

11.39

0.64

0.63

0.65

1.89

1.82

2.00

Source: private estimations based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

The impact of the DIIAF was measured with reference to two variables: the level of investment in fixed assets and the level of productivity of companies during 2012. The productivity metric takes into account two further estimates: labor productivity and TFP.27 The difference in the impact variable averages between the control and treatment groups indicates that companies that use the incentive (treatment group) record greater investment in fixed assets and greater labor productivity. However, only after applying the PSM effectiveness evaluation technique can we draw conclusions over whether the DIIAF actually generates higher levels of investment and productivity among the companies using the incentive. 28 The PSM method uses a process known as matching, which involves trying to find as similar a control company as possible for each treatment company. To develop the PSM, we first require an estimation of the likelihood of companies to make use of the government incentive, which will give us a score that reflects the conditional likelihood of program uptake. We then look for the non-beneficiary (in the control group) with the nearest score. 29

27 The labor productivity variable is calculated by dividing gross turnover by total wages and salaries. The TFP is calculated based on the INEGI methodology, which in turn is based on the KLEMS model (see Appendix 3). 28 Although it would appear that the control and treatment groups are similar, some differences may exist, which must be removed. This is achieved using a common support area whereby the treatment and control group characteristics are equalized to ensure a better balance between them. 29 This score, or likelihood of program uptake or otherwise P(X), is obtained from the a probit model estimation in which the dependent variable takes the value 0 if the company belongs to the control group, and 1 if it belongs to the treatment group. The sector to which each company belongs, the region where its plant or head office is located and type of business entity, are considered explanatory variables. The estimation model originally included company age, but this proved meaningless and the decision was taken to remove it from the model. It was also proven that the probit model was compliant with the common support and balance properties. See Appendix 3 for more details. 68


Different methods are developed to perform matching: nearest neighbor, Kernel, radius and stratification.30 If the program was to have an effect on the variables under study, we would see greater investment in fixed assets and/or increased productivity in companies that used the DIIAF compared to those that did not. This increase would be statistically significant.31 Table 5 shows the results obtained when evaluating the DIIAF’s effectiveness over the company investment of fixed assets. For each of the matching methods used, we can observe that the DIIAF did not produce increased investment, which means that the DIIAF had no impact on investment.

Table 5. The DIIAF had no impact on investment in fixed assets No. of Treatments

No. of Controls

Treatment Effect

Standard Error

t

H 0= 0 Ha > 0

Nearest neighbor

154

178

2.09

2.05

1.02

H0 not ruled out. No impact.

Stratification

150

206

2.71

1.99

1.36


Kernel

154

209

2.16

2.10

1.03


Radius

153

208

2.88

1.97

1.47


Source: private estimations based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. N.B. Nil hypothesis H0=0 indicates that the DIIAF did not generate increased investment. Ha>0 indicates that the DIIAF had a positive impact on company investment in fixed assets.

Although the DIIAF was found to have some impact on the labor productivity of companies, this was not found to have been statistically significant in all cases of matching used, meaning that the DIIAF did not produce increased labor productivity of companies (see Table 6).

30 Nearest neighbor: the control group observation is selected based on its nearness to that of the treatment group in accordance with its Kernel propensity score. Treatment group companies are compared against a weighted control group average. Stratification separates propensity scores into categories (quintiles). In each quintile, matching is sought between treatment and control companies. Unlike the method above, the Radius method defines a neighborhood enclosed within a set diameter, thus limiting the differences that could exist between propensity scores for matching. 31 Significance starts at 5%. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

69

Table 6. The DIIAF had no impact on the labor productivity of companies No. of Treatments

No. of Controls

Treatment Effect

Standard Error

t

H 0= 0 Ha > 0

Nearest neighbor

146

161

43.28

82. 99

0.52


Stratification

142

186

67.19

91.93

0.73

Kernel

146

189

60.96

73.44

0.83


Radius

145

188

61.28

77.04

0.80


Source: private Mexico, 2013.

estimations

based

on

the

Business

Competitiveness

Survey.


Ethos

Public

Policy

Lab.

N.B. Nil hypothesis H0=0 indicates that the DIIAF did not generate increased labor productivity. Ha>0 indicates that the DIIAF had a positive impact on the labor productivity of companies.

Finally, the above outcomes remain true for total factor productivity. In other words, the

not increase the TFP of companies (see Table 7).

DIIAF did

Table 7. The DIIAF had no impact on the TFP of companies

Nearest neighbor Stratification Kernel Radius Source: private Mexico, 2013.

No. of Treatments

No. of Controls

Treatment Effect

Standard Error

T

H0= 0 Ha > 0

151

176

0.32

0.27

1.19


148

205

0.23

0.26

0.89


151

209

0.22

0.30

0.74


150

208

0.12

0.25

0.48


Business

Competitiveness

estimations

based

on

the

Survey.

Ethos

Public

Policy

Lab.

N.B. Nil hypothesis H0=0 indicates that the DIIAF did not generate increases in TFP. Ha>0 indicates that the DIIAF had a positive impact on the TFP of companies.

As such, it is clear that the DIIAF did not produce the outcomes expected based on its design and objective.

The government incentive did not boost the productivity of companies in Mexico.

70


However, there was a loss of revenue associated with this incentive which, although it gives an indication that the incentive was in fact used, merely reduced the tax costs of some companies without achieving the objectives set out at the time of its implementation. The following section adds to this analysis by providing the opinions of entrepreneurs on the DIIAF, on the factors that impact on investment, productivity and competitiveness, and on the public policy alternatives that could prove more efficient in raising business competitiveness.

6.2.3. ENTREPRENEUR OPINIONS ON THE IMMEDIATE DEDUCTION OF FIXED ASSET INVESTMENTS In an evaluation process such as this, we cannot ignore the opinions of the key actors involved. Finding out the perceptions of Mexican entrepreneurs in relation to the DIIAF is essential. The Survey plays a key role in this by answering the following questions: Was the DIIAF a determining factor in increasing company investment and productivity? Were entrepreneurs satisfied with the operability? What alternatives do entrepreneurs now demand in terms of investment incentives? Below, we will describe the experience of entrepreneurs in their use of the DIIAF and its influence in aspects such as investment, productivity and competitiveness.


71

6.2.3.1 WHAT INHIBITS INVESTMENT IN MEXICO? Investment decisions are one of the biggest challenges and issues that entrepreneurs have to deal with, since the profitability and success of their companies depends on them. One of the key questions that needs to be answered is: What factors determine the decisions of companies over investment, productivity and competitiveness in Mexico? In this respect, company investment depends on several factors that may vary based on a company’s size, operating region, age, business cycle and other characteristics. However, as we can see in Graph 12, a dearth of financing, scant government support and a lack of

tax incentives are the biggest factors inhibiting business investment in the country. Graph 12. A lack of financing inhibits investment in Mexico

32.48

16.37

LACK OF GOVERNMENT INCENTIVES

14.58 INTEREST RATE VARIATIONS

LACK OF FINANCING

20.72

13.04

ECONOMIC GROWTH EXPECTATIONS

SCANT GOVERNMENT SUPPORT

Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013. N.B. Quantities expressed as percentages.

72


1.53

EXCHANGE RATE

1.28 OTHER

Graph 13 shows the limited access that entrepreneurs have to bank loans. As we can see, 63%

of the companies surveyed revealed that self-funding was their main source of financing, while only 16% of the sample are formally funded through a bank loan scheme. Whereas, 9% of entrepreneurs say that vendor credit is their main source of financing. Other sources of liquidity mentioned include savings funds, government or foreign organization credit schemes, and loans from family and friends.

Graph 13. Six out of ten companies finance their investment out of their own funds SOURCE OF FINANCING OWN FUNDS

63.47

BANK LOANS VENDORS

8.52

FOREIGN ORGANIZATIONS SAVINGS FUND

1.35

GOVERNMENT SCHEMES FAMILY OR FRIENDS

0.38

15.77

1.94

0.82 importancE


If we separate companies by whether they export or not, a pattern emerges that can prove useful in ascertaining the factors that inhibit investment in fixed assets. The investment dynamics of an export company and one oriented towards the domestic market are diametrically opposed. Due to their high level of exposure to the international market, export companies must meet operational criteria that demand greater efficiency in their activities. According to Bilkey (1978), in order for this to be achieved, greater investment in fixed assets is most certainly required. On the other hand, by operating exclusively within a regional framework, the investment of non-export companies is subject to operational criteria that are far different from those of the international environment.


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Given this scenario, it would be easy to infer that the factors inhibiting investment in fixed assets are radically different for export companies as they are for non-export companies. However, as Graph 14 shows, the main factor that inhibits investment in both categories of business is a lack of financing. For non-export companies, the next investment inhibitors in order of importance are scant government assistance and a lack of tax incentives for investment. We see a different pattern for export companies, where interest rate and exchange rate variations and economic growth expectations occupy second and third place respectively in the table of investment inhibitors. It is only natural that, due to their integration in processes of international trade, these companies are more exposed to the volatility of these macroeconomic variables.

Graph 14. Behind a lack of financing, interest rates and exchange rates affect export company investment. TYPE OF COMPANY

determinant

EXPORTER

NON-EXPORTER

28.65

LACK OF FINANCING INTEREST RATE AND EXCHANGE RATE VARIATIONS POOR GOVERNMENT SUPPORT FOR INVESTMENT LACK OF TAX INCENTIVES FOR INVESTMENT

35.60 14.21

20.65 13.55

20.88

16.39

16.04

17.94

ECONOMIC GROWTH EXPECTATIONS

12.39

2.84

OTHER 0

0.88

10 20 30 40 50 60 70 80

0

10 20 30 40 50 60 70 80

PERCENTAGE

PERCENTAGE


Of the total investment in fixed assets by companies during the period analyzed, just 11% took place using the DIIAF. Just 15% of entrepreneurs said that the DIIAF was generally a determinant in the procurement of fixed assets. These findings back up the results of the effectiveness and cost-benefit evaluations since, operating as it did, the DIIAF was unable to promote greater capacities among entrepreneurs to invest in fixed assets.

74


In Graph 15, each line represents one of the companies that took part in the survey, giving a clear indication that the DIIAF tended to be used by companies with higher turnovers, whereas the companies recording lower turnovers that were surveyed, on aggregate, did not heavily use this government incentive. Similar findings proved important when they were used by the Federal Executive to argue that the incentive should be repealed under the 2014 Social and Tax Reform.

Graph 15. Companies with low turnover rates did not use the DIIAF

DIIAF USE BASED ON COMPANY TURNOVER (MOP) MILLIONS OF PESOS 2,500 mOp

TURNOVER

2,000 mOp

1,500 mOp

1,000 mOp

500 mOp

0 mOp 0

2010

DOES NOT USE THE DEDUCTION

2011

2012

DOES USE THE DEDUCTION



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6.2.3.2. WHAT DO COMPANIES NEED TO BE MORE PRODUCTIVE? Understanding the determinants of the productivity of companies is essential in order to shape public policy to meet their needs. As Graph 16 shows, entrepreneurs believe that investment in fixed assets is the most influential factor in productivity. In order of importance, the second factor most often mentioned by entrepreneurs was input costs and the third was organization of the production process. Greater investment in fixed assets allows companies to increase their operating capacities. Whereas, competitive input costs and sensible selection improve the operational efficiency of organizations. Finally, the organizational principles of the production process aim to provide an adequate specialization and division of labor within the company, so that the resources that are to be used, such as labor and machinery, are leveraged to their full potential and have a positive impact on productivity.

Graph 16. Investment in fixed assets is the main determinant of company productivity 35 30

PERCENTAGE

25

31.36

20

20.39

15

16.90

10

14.71

5

8.63

0 INVESTMENT IN FIXED ASSETS

INPUT COSTS

ORGANIZATION ACCESS TO OF THE PRODUCTION FINANCING PROCESS

7.24

INTRA-SECTOR OPERATING AND COMPETITION MAINTENANCE COSTS


76


0.76 LABOR REGULATIONS

6.2.3.3. WHAT IS HOLDING BACK COMPETITIVENESS IN THE COUNTRY? To analyze tax system performance, we must take into account its impact on the competitiveness of companies. In this respect, Graph 17 reveals that entrepreneurs believe that infrastructure

and the tax system are the most influential factors in the competitiveness of companies. Graph 17. The tax system impacts on the competitiveness of companies in Mexico 22 20 18

PERCENTAGE

16

19.91

18.43

14

16.86

12

16.23

14.62

10 8 6

8.13

4

5.82

2 0

infrastructurE

TAX SYSTEM

MACROECONOMIC STABILITY

MARKET EFFICIENCY

RULE OF LAW

HEALTH AND EDUCATION

SCIENCE AND TECHNOLOGY


Graph 18 shows that companies that

employed the DIIAF placed greater weight on the influence of the tax system on competitiveness. Infrastructure and the Rule of law come behind the tax system in order of importance as underlying aspects of company competitiveness. Whereas, in the view of those entrepreneurs who did

not use the DIIAF, market efficiency is the most determining factor in the competitiveness of their business units, alongside macroeconomic stability and infrastructure.


77

Graph 18. The tax system is the most important factor in the competitiveness of companies that did not use the DIIAF

factorS

HAS NOT UTILIZED THE DIIAF

HAS UTILIZED THE DIIAF

16.98

TAX SYSTEM

21.51

17.76

infrastructurE

19.76 18.15

7.61

RULE OF LAW MACROECONOMIC STABILITY

19.12 25.46

MARKET EFFICIENCY PUBLIC HEALTH AND EDUCATION

14.22 10.65

7.41

10.04

4.29 1.37

SCIENCE AND TECHNOLOGY OTHER 0

5

4.61 1.07

10

15

20

25

0

5

10

PERCENTAGE

15

20

25

PERCENTAGE


As far as export and non-export companies are concerned, we find a different pattern in relation to the determinants of their competitiveness. As Graph 19 shows, the factors that impact most on export company competitiveness are the tax system, market efficiency and macroeconomic stability, whereas for companies operating domestically, the three key factors are infrastructure, the tax system and macroeconomic stability.

78


Graph 19. Exporters view the tax system as the most influential factor in competitiveness

TYPE OF COMPANY

determinant

EXPORTER

noN-exportER

18.30

TAX SYSTEM

18.19

14.29

infrastructurE MACROECONOMIC STABILITY

21.29

17.04

16.82

18.05

MARKET EFFICIENCY

15.41

13.28

RULE OF LAW PUBLIC HEALTH AND EDUCATION

15.02

11.90

7.02

6.27

SCIENCE AND TECHNOLOGY

5.69

0.88

OTHER 0

2

4

0.55 6

8 10 12 14 16 18 20 22

0

2

4

6

PERCENTAGE

8 10 12 14 16 18 20 22

PERCENTAGE


Graph 20 reveals the factors of the tax system that have a negative impact on the competitiveness of companies. The Survey found a significant pattern: the set of companies surveyed stated high tax rates as the factor most detrimental to their competitiveness. As far as the second and third most important factors are concerned, the demand for administrative simplification and a fair tax system were those mentioned most often.


79

Graph 20. High tax rates limit business competitiveness

66.97

TAX RATES ADMINISTRATIVE SIMPLIFICATION

14.42 9.35

FAIR TAX SYSTEM TRANSPARENT TAX SYSTEM

7.75 1.31

TAX INCENTIVES AND BENEFITS

0.20

OTHER 0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

PERCENTAGE Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

Graph 21, on the other hand, presents the factors of the tax system that have a positive impact on competitiveness. Those interviewed agreed that, in order of importance, administrative

simplification, the existence of tax incentives and benefits, and a fair tax system have the most positive influence on competitiveness. Based on these

outcomes, administrative simplification, which we can understand as a lower number of requisites and procedures for fulfilling tax obligations, could contribute to increasing business competitiveness. Likewise, companies would also be in favor of an increase in the number of tax incentives and benefits for investment in fixed assets.

80


Graph 21. A simple tax system promotes competitiveness

30.84

ADMINISTRATIVE SIMPLIFICATION TAX INCENTIVES AND BENEFITS

28.32 23.70

FAIR TAX SYSTEM

9.90

TRANSPARENT TAX SYSTEM

7.24

TAX RATES 0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

PERCENTAGE Source: compiled privately based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

Although the DIIAF was a form of government support to companies, it appears that its design and implementation were inadequate. When we analyzed data from the Survey in relation to knowledge and use of the DIIAF, we found that 65% of large companies were aware of the incentive

and, although 73% of those used it at least once, only 23% continued using it. This suggests that companies tested its effectiveness, but were met with largely unsatisfactory results. Furthermore, according to the Survey data, the main reason that entrepreneurs made use of the DIIAF was to purchase machinery and equipment, as shown in Image 10.


81

Image 10. What was the DIIAF used for?

MACHINERY construcTION PUMPS

HEAVY

PURCHASE

construcTION

COMPUTER

MOTOR VEHICLES

STORAGE

transport COMPUTER

BUILDINGS

OFFICE

PLANT

VEHICLES

EQUIPMENT

TOOLS FURNITURE

REAL ESTATE


Following the changes brought in under the 2014 Social and Tax Reform, the Survey asked entrepreneurs about possible alternatives to the repeal of the DIIAF. As we can see in Image 11, the alternative mentioned most often was the option of greater financing. Clearly, one of the themes that companies

mention throughout this study is the lack of an environment that provides major business loans in Mexico. Other important aspects are the necessity of having competitive tax rates and other tax deduction, stimulus and assistance schemes targeted at investment. Analyzed from a financial perspective, the DIIAF was conceived as a mechanism for financing investment in fixed assets at preferential rates. Now that the proposal to repeal the DIIAF has been passed, companies in Mexico have practically been left without a tax scheme that provides alternatives for investment in fixed assets.

82


Image 11. Entrepreneurs’ demands for increased investment

CONTRIBUTIONS

LOWER

TAXATION

BENEFIT

isr

ENTERPRISE

MARKETS

ECONOMIC

AsSETS

TAXES iva

DEDUCTION

RETURN

LOW

SHARED GOVERNANCE

invoice DECREASE

EXTEND

GOVERNMENT

SIMPLIFICATION

low

INITIATIVE

TRADE

interesT OPENING

machinery

TAXPAYER

LESS

TAX

RATES incentivEs PROCEDURES PAYMENT

TERM

ASSISTANCE CREDIT

DECREASE net

TRANSPORTATION

MACHINERY

LOANS

infrastructurE

REDUCE

fiscal

FINANCING

STIMULI LONG

SUPPORT

PRODUCTIVITY


Entrepreneurs were also asked what changes they would make to the DIIAF for the incentive to work better. The most common suggestions included a range of aspects such as:

removing the geographical lock of the incentive, increasing tax deduction rates, removing needless requirements, simplifying its implementation and guaranteeing the continuation of the incentive in the interests of facilitating medium to long term investment planning.

With these changes, the DIIAF would have had an impact, under certain conditions and premises, on the competitiveness of companies in Mexico. For instance, if companies had drawn upon the DIIAF to increase their levels of investment, and if they had been able to choose the best fixed assets for their production processes, then depending on the investment cycle, the impact on productivity would surely have been direct and immediate. Once the DIIAF had impacted on the productivity of companies by increasing levels of investment in fixed assets, companies would surely have seen a rise in their levels of competitiveness as a consequence.


83

84


CHAPTER 7.

Conclusions and Recommendations This study presents an investigation based on quantitative and qualitative information on the efficiency and effectiveness of the DIIAF. The above was aimed at obtaining robust results and a better understanding of the issues relating to the implementation of this tax expenditure. In this chapter, we will outline the main conclusions of this study, underlining those relating to the impact of DIIAF on investment, productivity and competitiveness. We also present the views of entrepreneurs on the operability and practicality of the DIIAF, as well as the elements necessary to increase the competitiveness of companies in Mexico. The following conclusions, were drawn from the evaluation process: • Although the DIIAF was in force in Mexico for little over ten years (following its resumption in 2002), a detailed evaluation was not published containing information on its impact and profitability during this time. Likewise, no studies that justify its disappearance from the Social and Fiscal reform for 2014 became available.

Internationally, it is common for governments to complement the use of straight-line depreciations with immediate deductions and/or accelerated deductions, as is the case in the United States, some European countries, and Latin American countries •

at a similar stage of development as Mexico, such as Argentina, Chile, Brazil, and Colombia.

that the use of immediate deduction schemes on investments is generally targeted at certain strategic sectors or geographical areas, and • The international benchmark revealed

depends on the type and/or value of the asset, and company size.

• The cost-benefit analysis indicates that the DIIAF was an inefficient and costly incentive, since, for the duration of its application, its costs outweighed its benefits.


85

• According to the effectiveness analysis, the DIIAF did not boost the investment, labor productivity, or total factor productivity of enterprises in Mexico. •A

dearth of financing, scant government support, and a lack of tax incentives are the greatest factors inhibiting business investment in the country. In fact, 63%

of the companies surveyed revealed that self-funding was their main source of financing.

•Of the total investment of enterprises in fixed assets, the DIIAF was only used in 11%. Only 15% of entrepreneurs claimed that the DIIAF was a determining factor the procurement of fixed assets. • Entrepreneurs believe that investment in fixed assets is the biggest determinant for business productivity in the country. Entrepreneurs stated that high tax rates are the factor that hinders competitiveness the most, whereas administrative simplification, the availability of tax incentives, •

and a fair tax system are the aspects that most benefit competitiveness.

According to entrepreneurs, key changes to the DIIAF’s design which could enhance its operability are: removing the incentive’s geographical lock, raising deduction percentages, getting rid of unnecessary requirements, simplifying its implementation, and guaranteeing the continuation of the incentive to facilitate medium-to-long term investment planning. •

• Entrepreneurs demand the provision of greater financing and more attractive

tax deduction schemes as measures to replace the DIIAF.

86


The above conclusions lead to a series of recommendations that will enable the provision of elements that contribute to increased investment, productivity and therefore, competitiveness of companies in Mexico. The main recommendations of this study are:

1. DESIGN A NEW TAX INCENTIVE TARGETED AT STRATEGIC SECTORS AND FIXED PRODUCTIVE ASSETS The implementation of this recommendation requires that the federal government decide beforehand, based on its knowledge and experience, what are the strategic sectors of the Mexican economy. Once these have been decided, it is recommended that the tax incentive be targeted at these sectors. The increased productivity of strategic sector companies can undoubtedly lead to a stream of benefits for the rest of the economy, thus boosting economic growth. One supplementary measure is to restrict the use of the tax incentive to fixed assets which have the potential to increase the productivity of the strategic sectors in question.

2. ALLOW THE NEW TAX INCENTIVE FOR INVESTMENT TO BE EMPLOYED NATIONWIDE. Previously, the way that the DIIAF was designed did not allow companies situated outside of the metropolitan zones of Monterrey, Guadalajara and Mexico City to make use of the tax incentive unless certain requirements were met. However, it is in these areas that a significant quantity of fixed assets is concentrated. Furthermore, Nuevo León and the Federal District have a significant

number of highly productive enterprises. For this reason, we propose that the new tax incentive for investment should not have geographical locks attached, since we would expect the use of the incentive by companies in these areas to strengthen productivity on a national level. The above recommendations point to the design of a new tax incentive for investment: a strategic, targeted and therefore “smart” tax incentive. However, to increase its effectiveness, it should be employed in combination with measures such as the following:


87

3. DISSEMINATION OF PRODUCTIVE LOANS AND SUPPORT OFFERED BY FEDERAL GOVERNMENT AND OF THE BENEFITS ARISING FROM THE IMPLEMENTATION OF THE NEW TAX INCENTIVE FOR INVESTMENT. One of the findings of this study is that companies consider access to financing to be fundamental in boosting investment. This suggests that a promotion strategy is in need of implementation so that companies are fully aware of the productive credits and support offered by the different federal government departments (see Appendix 4). As a whole, all support provided to promote investment, via the tax

system or directly, must be promoted and disseminated.

Some of the activities suggested as part of this dissemination policy are:

• Online database. To reduce company ignorance of the tax incentives and production loans and support offered by government, we recommend that a microsite should be developed on the SHCP and the Ministry of Economy website, containing online databases with the most relevant information on the subject. The design of the database format should be such that the taxpayer can easily filter information of personal interest. Moreover, the information contained should be clear and specific so that taxpayers can quickly grasp what direct and indirect assistance is offered by the government for their development.

• Regular newsletters. On its website, the SHCP can publish newsletters on how to make use of certain tax expenditures, where it can also announce changes made in terms of their design.

• Social media. Government institutions that offer support targeted at investment should promote these programs on social media. We also suggest actions such as administrative simplification and the regular assessment of tax expenditures in the interests of increasing the competitiveness of the tax system. .

88


4. ADMINISTRATIVE SIMPLIFICATION One of the features of tax systems that Mexican entrepreneurs value most highly is simplicity. Despite the federal government having implemented a series of mechanisms to achieve this in recent years, a process

of continual improvement that will allow the complexity of the tax system to be reduced on a constant basis needs to begin. In this respect, best international practices and

recommendations can serve as a handbook for original and effective actions implemented for this purpose (see Appendix 5).

5. EVALUATION The regular evaluation of tax expenditures benefits decision making, since it can provide valuable information to justify decisions over their continuation, amendment or abolition. The evaluation of tax expenditures also promotes transparency and accountability, as well as government legitimacy. An in-depth evaluation of tax expenditures involves carrying out an analysis as to their effectiveness and efficiency. Given the above, the first step towards the evaluation of tax expenditures in Mexico is the setting of measurable objectives and performance indicators, as it is done with most direct expenditure programs. Subsequently, a sunset clause or other mechanisms ensuring the regular evaluation of said tax incentives must be established. Given that investment decisions depend on expected yields and growth expectations, the establishment of a sunset clause facilitates medium-to-long term company planning, since it provides certainty as to the duration of government incentives. Finally, the authorization of a tax incentive should come with a study comparing its effectiveness against that of direct expenditure programs to prevent nonprofitable incentives from being implemented.


89

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Zee, H. H., Stotsky, J. G., & Ley, E. (2002): Tax

appendix

APPENDIX 1.

INTERNATIONAL BENCHMARK OF GLOBAL INVESTMENT DEDUCTION SCHEMES Straight-Line Depreciation

Yes

Accelerated Depreciation

No

Immediate Deduction

Comments

Repealed

Country

Although it was applicable to most fixed assets, immediate tax deduction in Mexico was limited to investment outside of the metropolitan areas of Monterrey, Guadalajara and Mexico City.

No

Straight-line depreciation is generally applicable for fixed assets (except real estate), depending on the useful life of the good. Accelerated depreciation is applicable for capital acquisitions or infrastructural work, and allows for the depreciation of a percentage of Income Tax and/or the early repayment of Value Added Tax.

No

Most fixed assets are eligible for straight-line depreciation. Accelerated depreciation can be used for the deduction of assets used in research and development.

mExico Mexico

Yes

Yes

aRGENTINA

Yes

braZil Brazil

Yes


99

Country

Straight-Line Depreciation

Yes


Yes

Immediate Deduction

Comments

No

In Chile, both straight-line and accelerated depreciation allow a certain percentage to be deducted from Income Tax (ISR) based on the useful life of the asset. Accelerated depreciation can reduce the time taken under the straight-line method by a third.

Yes

Yes

COLOMBIA

Yes

No

Repealed

chile

The taxpayer can choose whether to use the straight-line or accelerated depreciation method to deduct fixed assets. Immediate tax deductions were repealed in 2011, but remain in effect for companies that have signed legal stability agreements. This enables 30% of all investments in fixed assets to be deducted from taxable income.

No

The Capital Cost Allowance can be used by individuals or corporations to depreciate fixed assets under the fixed percentages by asset type.

Yes

Tangible (with some exceptions) and intangible assets are eligible for straight-line depreciation. The Section 179 tax deduction, similar to immediate deduction schemes, allows total investment in certain assets to be written off in a single period, as long as this does not exceed 500,000 dollars. Whereas, accelerated depreciation in the United States uses the declining-balance method of amortization.

No

Fixed assets can be depreciated under the straight-line method, in accordance with the maximum percentages set out in Article 22 of the Income Tax Law Regulation.

CANADA

Yes

Yes

UNITED United STATES States

Yes

perU Peru 100


No

Country


Yes


No

Immediate Deduction

Comments

No

The value of new assets can be depreciated using the straight-line method in accordance with the maximum depreciation percentages authorized in the Income Tax Law, which are 5% for real estate, 20% for equipment, 25% for vehicles, and 50% per annum for other assets. When the procured asset is used or imported under the Transfer Tax exemption, the percentage set out in Article 30 of said law may be depreciated only. Agostini & Jorrat (2013) deem that this tax depreciation is implicitly accelerated in nature given the high percentages authorized.

Yes

Generally, assets with a value below 300 AUD are eligible for immediate tax deduction (even when these are not used for productive purposes). SMEs can instantly write off vehicles with a value of between 5,000 and 6,500 Australian dollars. Similarly, this deduction is applicable for fixed assets with a useful life greater than twenty five years.

Yes

Taxpayers generally have the choice between straight-line and accelerated depreciation. Certain assets are eligible for instant tax deduction, such as those used in agriculture, livestock and forestry, or assets with maximum value of 500 NZD.

EL SALVADOR

Yes

Yes

australia

Yes

NEW New zeALAND Zealand

Yes


101

Country


Yes


Yes

Immediate Deduction

Comments

Yes

Taxpayers can choose between straight-line and accelerated depreciation. It is not possible to employ both depreciation methods in a single year, but the taxpayer can decide to change from accelerated to straight-line depreciation. Accelerated depreciation uses the declining-balance method; i.e. in the first year, a percentage of the total is deducted, in the second year the same percentage of the remainder is deducted, and so on; in the final depreciation periods, the straight-line method is used until 0 or the minimum value provided by law is reached. Instant tax deduction is permitted for assets with a maximum value of 410 euros. Buildings can only be depreciated under the straight-line method.

Yes

In Austria, the straight-line depreciation is the only method generally permitted. However, it is possible to opt for accelerated depreciation if it can be proved that an asset is used intensively. Equipment can also be immediately deducted during a single period if it has a maximum cost of 400 euros.

No

Assets with a value greater than 40,000 crowns can be depreciated under the straight-line or accelerated method, but it is not permitted to change from one depreciation method to another for a single asset. Intangible assets are depreciated under the straight-line method over a period established by prior contract.

No

Fixed or mobile assets, whether tangible or intangible, are eligible for straightline depreciation in accordance with the percentages chosen by the company within an officially fixed range. Accelerated depreciation can also be selected, except for the depreciation of buildings and furniture. Rented assets can also be deducted.

Yes

austRia

Yes

Occasionally

GERMANY Germany

Yes

CZECH Czech REPUBLIC Republic

S PLV

VL

TRA

Yes

SPAIN Spain 102


Yes

Country


Yes


Yes

Immediate Deduction

Comments

Yes

Most fixed capital investments are eligible for straight-line depreciation, whereas accelerated depreciation is used for assets acquired in 2009 or for the benefit of sectors such as renewable energy and research. Assets with a value of less than 500 euros can be instantly deducted.

Yes

Under the straight-line depreciation method, Italy has a special provision allowing half of the total permitted amount to be deducted in the first year. Only investments in research and development can be immediately written off, or depreciated via the straightline method, over a five-year period.

Yes

A Capital Allowances System exists, consisting of: a) Writing Down Allowances, whereby 18% of the total investment in assets can be deducted under the straight-line method (in Northern Ireland, the full amount can be written off in this way); b) Annual Investment Allowances, whereby the full amount of all qualifying investments can be written off up for an amount of up to 25,000 pounds. Motor vehicles can be depreciated in accordance with their CO2 emissions.

No

All assets employed for business purposes can be depreciated under the straight-line or decreasing-balance method. Some assets are eligible for accelerated depreciation. Federal law establishes depreciation percentages, although each canton can set its own amount (they do not tend to do so).

FRANCE France

Yes

No

ITALY ITALY

UNITED KINGDOM

United Kingdom

Yes

Yes

SWITZERLAND Switzerland

No

Yes

Source: compiled privately based on (Agostini & Jorratt, 2013), (Legislative Assembly of El Salvador, 1991), (Bundeszentalamt für Steuern, 2013), (Canada Revenue Agency, 2013a), (Canada Revenue Agency, 2013b), (Deloitte, 2011a), (Deloitte, 2011b), (Deloitte, 2011c), (Deloitte, 2011d), (Deloitte, 2012a), (Deloitte, 2012b), (Deloitte, 2012c), (Deloitte, 2012d), (Deloitte, 2012e), (Deloitte, 2013a), (Deloitte, 2013b), (Deloitte, 2013c), (Deloitte, 2013d), (Deloitte, 2013e), (HM Revenue & Customs, 2013), (Internal Revenue Service [USA], 2013), (Junta de Gobierno de Chile, 1974), (Ministère de l’Économie et des Finances, 2013), (New Zealand Treasury, 2013) and (SUNAT [Peru], 1994). TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

103

APPENDIX 2.

INVESTMENT INCENTIVES IN MEXICAN STATES In addition to tax expenditures, subnational governments offer other kinds of incentives. As we will see below, the incentives within each category can vary entirely.

• Real Estate. The construction, acquisition or rental of the physical space where companies operate constitutes a significant startup cost. As such, governments create different kinds of incentives in relation to this item. For instance, Guanajuato, according to its state laws, grants cash awards for the purchase of land, the acquisition or construction of industrial buildings or the temporary payment of real estate leases (Official Gazette of the Government of the State of Guanajuato, 2013). Similarly, in accordance with the Economic Development Law of the State of Sonora, the government offers discounted prices to companies for the acquisition of real estate that belongs to state and municipal government. Schneider Electric, for instance, allocated 65 million dollars towards implementing its new Development and Innovation Center in Monterrey. The 312, 153 sq. ft. (29,000m2) of land where the company would set up was donated by the Nuevo León state government. Moreover, the company was also granted subsidies of a million dollars (Pinal, 2013).

• Infrastructure and Public Services. Having adequate communication channels in place is an essential requirement of multinational companies, as it allows them to maintain a suitable flow of raw materials and distribution of its products. Likewise, the supply of inputs such as water, electricity and natural gas also streamline production. In this respect, the Investment Promotion Law for the Economic Development of Sinaloa states that the following stimuli may be awarded: estate leveling, construction of access roads, construction of acceleration/deceleration lanes, paving of access roads, construction of electrification works, construction of water outlets, construction of artesian wells, construction of sewers, and the construction of railroad spurs. We can refer to the example of San Luis Potosí to see how the award of these kinds of incentives can be a determinant in investment decisions. In an effort to attract investment from General Motors (GM), the government of San Luis Potosí offered 104


the company a 60 million dollar incentive package in 2008, which included the construction of access roads, two water wells, an electrical substation and a rail connection. Moreover, the federal government offered to donate land to GM at the chosen site (Hernández, 2008).

• Machinery and Equipment. Support for initial investment in machinery and equipment can also be attractive for companies. For this reason, the government of Guanajuato awards cash incentives to multinational companies based on the number of jobs that will be created and the investment amount. This kind of incentive can be spent within certain expenditure categories, such as the machinery or equipment procurement (Official Gazette of the Government of the State of Guanajuato, 2013). Similarly, in accordance with the Economic Development and Employment Promotion Law of Yucatán the government of the state offers companies funding that may be used for the procurement, transfer and installation of machinery and equipment that adds value to production (Official Gazette of the Government of the State of Yucatán, 2010).

• Human Resources Development. Although the presence of qualified labor is an attribute valued by multinationals when they invest, some investments require specific worker skills, which makes training necessary. In this respect, the government of the state of Guanajuato awards cash incentives for company staff training. These training incentives are allocated towards scholarships, meeting transport and accommodation costs, purchasing life insurance, paying for medical expenses and other items (Official Gazette of the Government of the State of Guanajuato, 2013). Likewise, under the legal framework of Yucatán, the government promotes human resources development through special training programs and financial support, as well as by granting scholarships (Official Gazette of the Government of the State of Yucatán, 2010).

• Professional Services Recruitment.

The state government of Guanajuato awards cash incentives for companies to conduct specialized research or to recruit professional services for consultancy projects in specific matters such as: localization and feasibility studies, environmental impact and/or traffic engineering studies, soil mechanics studies, etc. (Official Gazette of the Government of the State of Guanajuato, 2013). The Economic Development Law of Sonora also states that the government shall make financial support available for pre-investment and feasibility studies.

• Bureaucratic Procedures.

Dealing with the bureaucracy necessary to set up and operate a company can involve significant investments of time and resources. As a result, Sinaloa offers guidance and support for dealing with such procedures (CIT Sinaloa, s/f ). Similarly, the Investment and Employment Promotion Law of the state of Nuevo León states that companies will be given support for their bureaucratic procedures with federal, state and municipal authorities.

• Supply Chain.

Creating tie-ins between multinational companies and local vendors does not only act as an incentive to attract investment; it also improves the domestic economy by forming


105

supply chains. The Vendor Development Program for Large-Scale Industry in San Luis Potosí enables Micro, Small and Medium Enterprises (MSMEs) to link up with multinational investors as vendors (SEDECO, 2010). Similarly, although the Investment and Employment Promotion Law of Nuevo León lacks detail, it does state that the government shall provide support for establishing tie-ins between companies and potential vendors.

• Using Digital Media to Provide Relevant Information to Investors. Interaction between state government and companies enables states to show potential investors what they have to offer, which can in turn lead to higher levels of investment. As a result, it is becoming increasingly common for states to achieve greater outreach of the benefits and incentives offered via government websites. Some states have even designed websites with the sole objective of providing information to investors, as is the case of Sinaloa, at www.sinaloaindustrial.com.

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APPENDIX 3.

METHODOLOGY 3.1 COST-BENEFIT EVALUATION As part of the socio-economic evaluation, it would be useful to know whether social wellbeing increases or decreases as a consequence of undertaking a particular project. If it is estimated that a project will result in greater wellbeing, this project should be taken forward. To arrive at this decision, it is not enough to simply take into account the costs and benefits involved, but rather, the impact that the project will have on other national economic agents should also be considered. As mentioned by the Center of Studies for the Socio-Economic Preparation and Evaluation of Projects, “the socio-economic evaluation aims to determine the extent to which the availability of goods and services in the country is altered as a consequence of a project’s undertaking” (Mancur, 1992). In other words, the cost-benefit analysis will help to determine a project’s efficiency. In this case, the evaluation’s outcome is obtained by comparing the costs and the benefits in monetary terms. For the social evaluation of projects, real resource flows must be created and evaluated based on the resources used and generated in the project. The first step in developing a project’s cost-benefit analysis is to find out the project’s specific objectives and scopes. In the case of the DIIAF, and as explained in the statement of reasons behind the 2002 LISR proposal, the main objective was to impact the growth of the national economy through gross fixed capital formation.

3.1.1. ESTIMATION OF COSTS To estimate the costs of the DIIAF, we used the PGF data for Mexico published by the SHCP, which used the revenue-loss method, in which the revenue lost due to the implementation of a tax treatment is estimated. We should underline that the government loss caused by the tax expenditure only serves as a good approximation of the costs of the DIIAF, since these estimates do not take into account changes in the behavior of taxpayers as a result of differential treatment having been repealed, or its repercussions on the rest of the economy..


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3.1.2. ESTIMATION OF BENEFITS To estimate the benefits of the DIIAF, we take the value of production that results from the investment associated with the incentive. The process for determining benefits is based on the estimated KLEMS model used by the SCNM of the INEGI to get the TFP for Mexico, as published August 2013:32

ƒ(·) = (K, L, E, M, S) And the variation in the level of production is:

∆Y=αΔK+βΔL+γΔE+εΔM+ΔS+ΔA Where the variables K, L, E, M, S, represent for capital, labor, energy, materials and services. The Greek symbols α, β, γ, ε, θ determine the factor proportions in the value of production and A is the TFP (see Image 1). These parameters and proportions estimated by the INEGI are used together with the SCNM’s aggregated data to calculate the benefits.

32 http://www.inegi.org.mx/prod_serv/contenidos/espanol/ bvinegi/productos/derivada/cuentas/bienes%20y%20 servicios/produc_total/product_total_90_11/PTF_SCNM.pdf 108


Imagen 1. GRAPHIC DISPLAY OF THE KLEMS MODEL Y

gdp growth (%per annum)

It is therefore a partial and static equilibrium analysis, since the estimates show the tax revenue relinquished in a given year due to the tax policy’s implementation in that same year, without considering the effects that this policy may have in subsequent years. However, this estimate is used internationally and allows for the simple monetization of tax expenditure costs.

DIIAF Capital

Capital

Capital

labor

labor

energy materials services

energy materials services

tfp

tfp

without DIIAF

with DIIAF

Source: Compiled privately.

In particular, to estimate the direct benefits for each year, we use total GDP (Y), gross fixed capital formation (ΔK), the economic growth for each year (ΔY), and the total cost of the DIIAF.33 We developed three basic scenarios to estimate the amount invested in fixed assets associated with the DIIAF. The first scenario contemplates an adjustment factor of 18%, which is the deduction rate for investments made between 2008 and 2011 according to the statement of reasons behind the 2014 Social and Tax Reform proposed by the SHCP.34 The second takes information obtained from the Survey, which reveals that, of the total invested by entrepreneurs between 2010 and 2012, only 11% was deducted using the DIIAF. As such, the data on private sector levels of Gross Fixed Capital Formation reported by the Bank of Mexico was weighted to the 11% reported in the Survey.

33 For the purposes of simplifying calculations, we assumed that the total approximate cost of the DIIAF is equal to the resources used in fixed asset formation. 34 http://www.apartados.hacienda.gob.mx/presupuesto/ temas/ppef/2014/ingresos/06_lir.pdf

The third scenario estimates the amount invested based on revenue loss, using the following

ISRCD = (U − D) * t

intuition:

D=I*d

When:

In view of the above, we can rewrite revenue loss

P=

equation as follows: Revenue loss in thousands of pesos

ISRSD = Tax revenue in thousands of pesos, in a

P = (U * t) − (U − I * d) * t

climate without immediate tax deduction

Or simply:

ISRCD = Tax revenue in thousands of pesos, in a

P = I*d*t

climate with immediate tax deduction

And to calculate the amount invested by

U = Company profit reported to the tax authority in thousands of pesos

D =

I = P /d * t

Immediate deduction of fixed assets in

thousands of pesos

As we did with the two previous scenarios, we weigh the amount I by the capital contribution

I = Company investment in thousands of pesos

to economic growth to obtain the benefits figure used in the cost-benefit analysis.

t = Average rate of Income Tax d = Average

companies in relation to this revenue loss

Finally, we consider the approximate cost of the immediate tax deduction rate for

fixed assets

incentive. Using this figure to get the proportion of

Based on the above, we can consider revenue loss as the sum of tax revenue in an environment where immediate deduction is not available, less the tax revenue in an environment where fixed assets are in fact eligible for immediate deduction:

P = ISRSD − ISRCD

DIIAF as the investment amount generated by the total investment that can be attributed to the DIIAF for a certain period (Kd), in order to subsequently, by replacing the estimated parameters with the KLEMS model and getting the capital contribution to economic growth (αΔK), calculate the specific contribution of the investment generated by the DIIAF (DIIAF Capital) to output growth (αΔKd) for each evaluation horizon period.

Where:

ISRSD = U * t TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

109

3.1.3. ESTIMATION OF EXTERNALITIES

As such, the benefits for each period are calculated as follows:

B1 = αΔKdt for t = 1

The main externalities associated with investment

B2 = αΔKdt + (1 − δ) αΔKdt for t = 2

in fixed assets are the driving of technological

B3 = αΔKdt + (1 − δ) αΔKdt + (1 − δ)2 αΔKdt for

progress and innovation development in the associated industry or sector, improved productive conditions in the geographical region, increased competitor investment in fixed assets, higher wages and improved worker conditions of the

t=3

B4 = αΔKdt + (1 − δ) αΔKdt + (1 − δ)2 αΔKdt +

(1 − δ)3 αΔKdt for t = 4

B5 = αΔKdt + (1 − δ) αΔKdt + (1 − δ)2 αΔKdt +

investing company. However, due to a lack of

(1 − δ)3 αΔKdt for t = 5

data in the country, the precise measurement

…

and estimation of these effects on the Mexican economy as a whole goes beyond the scope of

B10 = αΔKdt… + (1 − δ) αΔKdt + (1 − δ)2 αΔKdt

this project.

+ (1 − δ)3 αΔKdt for t = 10

Finally, to estimate the benefits, we take into

3.1.4. AGGREGATION OF COSTS AND BENEFITS

account the statistical research carried out by Bank of Mexico in relation to the effects of fixed capital investment and output, which has shown that the behavior of gross capital formation is not only procyclical in relation to GDP, but also that the effects of investment on production are sustained for up to four periods. This dynamic can be explained by the time that investments in fixed assets take to yield results, and can also be the outcome of the externalities of investment, since these also directly impact on output. Thus, to calculate the total net benefits, we will take the aggregation of the impacts of gross fixed asset formation over four years, with temporal discounts applied using a capital depreciation factor.

Once the costs and benefits have been identified, they are aggregated using the following formula, and the project’s net present value (NPV) is estimated.

VPN = Σ10t = 1 ( Bt − Ct ) ( 1 + r* ) t Where, Bt = benefits for the period t. Ct = costs for the period t. Whereas r* is the social discount rate, representing the opportunity cost to the country of using funds to finance a project. As such, if the NPV is greater than zero, the project is profitable. In Mexico’s case, this opportunity cost is 12% according to the SHCP Investment Unit guidelines

110


for

producing

and

presenting

cost-benefit

analyzed for investment programs and projects.

35

3.2. EFFECTIVENESS EVALUATION: PROPENSITY SCORE MATCHING The objective of the effectiveness evaluation is to find out whether there is a causality between a government policy or program and the variables that might be impacted by such a policy. In technical terms, this involves estimating the “average treatment effect on the treated”, defined as:

is available to evaluate a program, we cannot know the outcome for a unit if it had not participated in a given program in which it did in fact participate E (Y0 | X,D = 1). To solve this problem, we use a hypothetical, which we call the counterfactual (Talavera, 2004). In this case, the program’s impact would be the difference between the outcome observed using the program, and what would have happened without it (counterfactual). In practice, we get this counterfactual by creating two groups: the control group (who do not participate in the program) and the treatment group (who participate in the program). Here, it is important that the control group is equal to the treatment group in all of its observable and

αATET = E (Y1 − Y0 | D = 1, X) = E (Y1 | X,D = 1) − E (Y0 | X,D = 1)

non-observable characteristics, except program

Where Y1 is the value of the response variable for

since, without it, both groups would be equal

a unit that has participated in the program, and Y0

(Pomeranz, 2011).

is the value of the response variable for the same unit when it has not participated in the program, with X observable and non-observable actor characteristics, whereas D = 1 indicates that the

participation. Then, any difference following the intervention can be attributed to the program,

To create this counterfactual, various methods can be used, which we can separate into two categories: experimental and quasi-experimental

unit was a beneficiary of the program.

design. The former requires random beneficiary

The problem with the above is that, for a single

practice. As an alternative, there are two quasi-

unit, we can only see what happened when it

experimental methods, which create fictitious

was a beneficiary of the government action, and

randomization in the selection of treated parties,

not what would have happened without this

each with similar observable variables. In other

intervention. This means that, although E (Y1 | X,D = 1)

words, control groups are created which are

selection, which is very difficult to achieve in

similar to the treatment group, at least insofar as their observed characteristics. Despite the 35 http://www.shcp.gob.mx/LASHCP/MarcoJuridico/ ProgramasYProyectosDeInversion/Lineamientos/costo_ beneficio.pdf

disadvantages that can be present in this kind of design, it is in fact recommended since it can


111

be based on sources of existing data and can be performed immediately following the program’s implementation (Talavera, 2004). This quasi-experimental design has a number of techniques within it, the most common of which is matching. This technique seeks to make a control group similar to the treatment group based on a set of observed covariates or an index known as the propensity score, which represents the “conditional probability of assignment to a particular treatment given a vector of observed covariates” (Rosenbaum & Rubin, 1983). The PSM method requires two key assumptions to be met: Assumption 1. That an equilibrium exists between the set of actor covariants (X). Units with the same Propensity Score have the same distribution of observable covariants, regardless of whether they are control or treatment.

D X | p (X) Assumption

2.

Conditional

independence.

Program participation is independent of the potential

objective

variable

observable covariants X.

(Y c, Y T D) | p (X)

112


values,

given

Based on this assumption, an X-conditioned impact variable for the control group is made to have the same distribution function as it would have had in the treatment group if the incentive had not been employed, thereby ensuring the following equality:

E [ YCi | Di = 1, p (X) ] = E [ YCi | = 0 ] The equation above means that vector X includes all variables that affect participation (D) and the variable under study (Y). In this study, we use the pairing method (PSM) to generate the counterfactual, which involves estimating a logit or probit model in relation to program participation or employment. From this, we obtain a score that reflects a company’s predicted likelihood of applying the DIIAF given a set of observed covariants. We then look for a control company with the nearest propensity score for each treatment company (matching). Then, we compare the outcome indicators, and the difference there between gives us an estimation of the profit generated by the program for each unit. Finally, we calculate the mean of company profits to get the total average profit. The outcomes obtained from developing the PSM pairing method to determine DIIAF effectiveness are outlined below.

Table 1. Descriptive statistics of the control and treatment groups Variable

Number of companies Average workers Average age (years) Economic sector Mining

Total

Control

Treatment

364

210 (57.69%)

154 (42.31%)

242.47

226.13

264.90

22.15

21.89

22.51

0.82

0.48

1.30

Construction

4.67

6.19

2.60

Manufacturing

35.44

31.43

40.91

Wholesale trade

35.44

33.33

38.31

Retail trade

18.68

21.43

14.94

Mass Media

1.65

1.43

1.95

Real estate and lease services

3.30

5.71

0.00

North

40.93

40.00

42.21

North-Central

21.43

24.76

16.88

Central

24.45

21.43

28.57

South

13.19

13.81

12.34

Sociedad anónima

43.68

48.57

37.01

Sociedad de capital variable

48.90

43.33

56.49

Other

7.42

8.10

6.50

Investment in fixed assets (millions of pesos)

9.54

8.18

11.39

Labor productivity (millions of pesos)

0.64

0.63

0.65

TFP

1.90

1.82

2.00

Region

Type of business entity

Source: private estimations based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

The variables used to estimate the probit model are: company sector, plant or head office region, and type of business entity.


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Table 2. Probit estimation of the likelihood of program participation Variable

Coefficient

Standard Error

z

P>z

Sociedad anónima Other type of business entity Mining Construction Manufacturing Wholesale trade Retail trade North North-Central South Constant Observations LR chi2(9) Log likelihood

-0.5453

0.2315

-2.3500

0.0190

-0.5301

0.4538

-1.1700

0.2430

2.4603

1.3938

1.7700

0.0780

0.6088

0.8726

0.7000

0.4850

1.5123

0.6745

2.2400

0.0250

1.4756

0.6707

2.2000

0.0280

0.9122

0.6968

1.3100

0.1900

-0.1527

0.2773

-0.5500

0.5820

-0.4113

0.3426

-1.2000

0.2300

-0.2324

0.3818

-0.6100

0.5430

-1.1616

0.6752

-1.7200

0.0850 361 21.79 -235.1266

Source: private estimates based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

A first estimation included the business size and age variables, however, given the low explanatory power of these variables, it was decided to remove them. The inclusion of other variables with a low explanatory power answers the need to achieve the best possible fit, since the important thing in this case is that the estimation should be useful for finding out the likelihood of the program participation of each unit in the sample. It should be considered that a sizeable proportion of the likelihood of participation is explained by non-observable covariants, which would explain the relatively low level of the model’s goodness of fit (Talavera, 2004). Although it would appear that the control and treatment groups are similar, some differences may exist, which must be removed via a common support area where the characteristics of the treatment group units are similar to those of the control group.36 The following graph shows the common support area for control and treatment group companies. The common support area is situated within a range of 0.1365 to 0.6548. 36 The balancing trial was satisfied. 114


Graph 1. Common support area

density

4 3 2 1 0 0 0.2 Probit Propensity Score

0.4 treatment

0.6 control

0.8

Source: private estimates based on the Business Competitiveness Survey. Ethos Public Policy Lab. Mexico, 2013.

Using the above, we can calculate the estimated value of the likelihood of program participation, P(X). This is the score used for matching. Several methods exist, including Nearest Neighbor, Kernel, Radius, Stratification.

Box 1. Advantages and Disadvantages of Matching Methods.

Nearest Neighbor

Matching Method

Description

Advantages

Disadvantages

• If control and treatment groups • This is the most commonly used are distributed differently (the since it is the simplest to implement. likelihood of having a near neighbor is low), matches are made at greater • The control group • It can be used in two ways: distances, which in turn increases observation is selected i) replacement and ii) nonvariance and estimation errors. based on its nearness to replacement, which allow for sample the treatment group in balancing when there are no more • If using the non-replacement method, bias and the variance view of their propensity treatment or control observations. scores. • If using the replacement method, between observations can increase i.e. when a control observation can depending on the order in which be used in more than one match, pairs were matched, and so average pair quality will increase and additional randomized trials should be conducted to avoid these kinds bias will decrease. of problems.


115

Radius

Kernel

Matching Method

116

Description

Advantages

• As a non-parametric estimator, and by using averages of all • Treatment group comsubjects in the control group panies are compared (rather than just some units against a weighted conlike in other methods), Kernel trol group average. presents less variance by using more information.

• Defines a neighborhood enclosed within a radius, and limits differences that exist in propensity scores for matching.


Disadvantages •Since this method takes the average of all control units into account, the common support area takes on greater importance here because, if it is not calculated correctly, observations that are not suitable for pairing may be considered, thus increasing variance and estimation errors, and causing inefficient results.

• Corrects the disadvantages of the “nearest neighbor” method when there is a distance between • If a large number of matches pairs by imposing a tolerance cannot be found between radius for observations that are treatment and control units, similar. variance between estimates • Minimizes variance between increases. control and treatment pairs, thus • It is impossible to know in raising match quality. advance what an appropriate •Balances the sample by using tolerance radius would be, so each observation more than its estimation can be arbitrary once for a unit through the use of trial and error. • Minimizes the risk of matching pairs that are unsuitable for estimation.

Stratification

Matching Method

Description

• Group propensity scores into intervals (quintiles). In each quintile, pair matches are sought between treatment and control companies.

Advantages

Disadvantages

• The number of strata grows exponentially, and therefore, if the number of covariants increases, the treatment’s • Under normal conditions and effects becomes increasingly with a balanced sample, the complicated to estimate. sample can be partitioned into quintiles, which can reduce the • Moreover, if normal conditions bias associated with covariants or a balanced sample cannot by 95%. be achieved, units must be partitioned into an increasing number of strata, which also complicates estimation.

In the interests of verifying the result robustness, control and treatment group matching was carried out using different methods: Nearest neighbor, Kernel, Radius and Stratification. The incentive’s impact was estimated in terms of the statistical significance of the difference between the results of control and treatment companies. If the program had a significant effect on investment or productivity, we would observe that investment (productivity) increased more for companies that used the incentive than those that did not. We can sum up this impact estimation with the following hypotheses and compare:

H0: Investment/productivity = 0 Ha: Investment/productivity> 0 If a nil hypothesis is ruled out, we would find that the program had a positive effect on investment/ productivity; if not, then the program did not lead to increases. It is worth underlining that the labor productivity used to measure DIIAF effectiveness for this variable was estimated using the gross profit per man-hour ratio; the TFP is that obtained using the KLEMS model outlined in section 3.1.2 of this Appendix. Furthermore, in the interests of evaluating bias and sample error for each matching method, the bootstrap technique was used with 50 repetitions.


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APPENDIX 4.

PRODUCTIVE LOANS AND SUPPORT FROM FEDERAL GOVERNMENT Through a number of direct expenditure programs, the federal government aims to incentivize company productivity. As such, some of the production credits and support on offer to promote investment are outlined below:

1. MINISTRY OF THE ECONOMY37 1.1 MICRO, SMALL AND MEDIUM ENTERPRISE SUPPORT FUND Support is offered to projects that promote the creation, consolidation and competitiveness of MSMEs and the entrepreneur initiatives. With this program, the government offers resources to pay a significant proportion of the total cost of the projects selected. Depending on the type of MSME, the resources allocated through the Fund can be spent on specific items such as training and consultancy, equipment and infrastructure, model transfer, promotion and training of instructors and consultants, technological innovation and development, preparation of studies and projects, etc.

37 Ministry of the Economy programs were retrieved on November 5th, 2013, at http://www.economia.gob.mx/conoce-la-se/ programas-se/programas-de-subsidios/reglas-de-operacion-y-padron-de-beneficiarios and http://www.financiamientoempren dedores.economia.gob.mx/ 118


1.2 ENTREPRENEUR FINANCING PROGRAM - SEED CAPITAL This program provides lending for the startup and initial stages of projects of entrepreneurs who form part of the SE’s National Business Incubation System. The projects selected can enjoy the following benefits: 1.-For Traditional Business and Intermediate Technology projects:

2.-For High Technology projects:

Amount: a minimum of 50,000 and a maximum of 500,000 pesos

Amount: a minimum of 200,000, up to 1.5 million pesos

Maximum percentage support: Up to 70% of the total cost of the project

Maximum percentage support: Up to 70% of the total cost of the project

Repayment period: 36 months

Repayment period: 48 months

Grace period: up to six months in capital

Grace period: nine months in capital

Entrepreneur contribution: at least 30% of the total value of the project

Entrepreneur contribution: at least 30% of the total value of the project

Types of projects eligible for financing include: development of a commercial prototype; machinery and equipment procurement; investment for product launch, expansion, modifications and reworks; registration of brands, utility models and patents; working capital for doing business.

1.3 PROGRAM FOR THE DEVELOPMENT OF THE SOFTWARE INDUSTRY Subsidies are awarded for projects by industries or actors associated with information technology. The program’s resources can be used to meet part of the project’s expenses under the following categories: training and certification; technological enablement and equipment; regulations and standards; technological uptake and production; innovation; marketing; business skill development studies; professional services; events; creation and reinforcement of funds, and; public policy acceleration.


119

2. NATIONAL BANK FOR FOREIGN TRADE38

2.1 WORKING CAPITAL LOANS

In general, BANCOMEXT programs aim to promote exports by Mexican companies. In this respect, programs 2.1, 2.2 and 2.3 described below are specifically allocated for:

particular, these loans can be used for production;

• companies substitutes;

that

towards helping perform production activities in foreign trade and foreign-currency revenues. In the purchase of domestic or imported raw materials; inventory compilation or maintenance; direct export sales; building and fitting industrial warehouses for sale or lease purposes.

• export companies or their vendors; • companies with revenues currencies, and their vendors;

These are loans of up to 100%, allocated

in

foreign

manufacture

import

• Mexican companies that import raw materials, supplies or components to manufacture products for international markets.

2.2 EQUIPMENT LOANS Equipment loans support national or imported new and used machinery purchases to expand and modernize companies’ production plants.

2.3 INVESTMENT PROJECT LOANS Loans of over three million dollars are granted to support the implementation, equipment, expanding or modernization of manufacturing and storage facilities, including machinery and equipment procurement. The program grants terms of up to fifteen years based on the investment project’s estimated cash flows. For new companies, funding is provided for up to 50% of the full project amount. For companies already in operation, loans can cover up to 85%

38 BANCOMEXT program information was retrieved on November 5, 2013, at: http://www.bancomext.com/ Bancomext/secciones/que-ofrecemos/index.html 120


of the full project or investment amount.

2.4 FINANCING TO BUILD INDUSTRIAL WAREHOUSES This loan aims to finance the building and equipment of industrial warehouses to be sold or leased to export companies. The beneficiaries of this program are construction or real estate companies developing industrial warehouses, and beneficiaries or their shareholders should preferably have a minimum of five years’ industry experience.

2.6 SUPPORT FOR THE AUTOMOTIVE AND SPARE PARTS INDUSTRY This program seeks to support the needs of the terminal industry and its supply chain with: • Direct loans for working capital, sales, equipment and capital projects. • Credit and stock market guarantees.

2.5 SYNDICATED LOANS

• Import and export letters of credit. This instrument seeks to spread the risk of financing operations in which a commonality of interests exists between different lenders who work through a lead bank that manages the lender-borrower relationship. BANCOMEXT can participate either as a guest or lead bank for syndicated loans. The beneficiaries of this loan can be:

• Structured loans for capital projects. • International factoring.

• Companies that need to cover their corporate and business financing requirements, such as working capital, investment, or infrastructure projects. • Companies engaged in direct or indirect export activities and vendors of companies with revenues in foreign currencies. • Companies substitutes.

that

manufacture

import


121

2.7 FINANCIAL SUPPORT FOR THE ELECTRICAL AND ELECTRONICS SECTOR

scaling stage (companies aged over two years, which are eligible to receive up to five million pesos). This financial support can be used for fixed assets (but not real estate), software and advance applications.

BANCOMEXT seeks to support the growth and competitiveness of electrical and electronics sector companies with: a) direct loans for working capital, sales, equipment, expansions and capital projects; b) import and export letters of credit, and; c) international factoring.

3.2 BUSINESS INCUBATOR STRENGTHENING AND NON-TRADITIONAL INCUBATION SCHEMES

3. NATIONAL ENTREPRENEUR INSTITUTE39

This aims to support the startup of competitive and innovative companies through business incubator strengthening and non-traditional incubation schemes. There are several categories of support, including investment in infrastructure and equipment (up to 30%).

3.1 HIGH-IMPACT ENTREPRENEURSHIP PROGRAM This program’s objective is to strengthen entrepreneurs of high-impact projects with the necessary tools to make their ideas attractive to investment or loan worthy. The program offers two support schemes: a) start-ups (companies operating for less than two years, which can receive up to three million pesos) and b) companies at the

39 National Entrepreneur Institute program information was retrieved on November 5th, 2013, at: https://www.inadem. gob.mx/convocatorias.html 122


3.3 VENDOR DEVELOPMENT Supporting companies for their incorporation into supply chains. SMEs and large companies can access this program when their project generate an economic, regional or sectorial impact, boost employment, or directly or indirectly benefit entrepreneurs and/or SMEs. Support can be used for manufacturing equipment and/or infrastructure, or for advanced management applications (management software).

3.4 REGIONAL COMPETITIVENESS Regional competitiveness is boosted through the development of total production, strategic liaisons and infrastructure projects, as well as projects that raise the competitiveness of MSMEs. The program is available to MSMEs, state and municipal governments, and large companies when their projects generate an economic, regional or sectorial impact, boost employment, or directly or indirectly benefit entrepreneurs and/ or SMEs. Support can be used for manufacturing infrastructure, equipment, and brand and/or patent registration fees.

3.5 ECONOMIC REACTIVATION This program boosts the economic development of specific regions with unfavorable economic conditions through productive projects and projects that raise the competitiveness of MSMEs and the employability of the population. The same people benefit from this program as from the Regional Competitiveness Program. Support can be used for manufacturing infrastructure, equipment, and brand and/or patent registration fees (including business startup expenditures).

3.6 ECONOMIC REACTIVATION FOR THE NATIONAL PROGRAM FOR THE SOCIAL PREVENTION OF VIOLENCE AND CRIME AND THE NATIONAL CRUSADE AGAINST HUNGER This program is available to state and municipal governments, specialized private organizations and large companies that present projects that generate economic impacts, strengthen competitiveness or directly benefit entrepreneurs and/or MSMEs situated in the 100 Municipalities participating in the National Program for the Social Prevention of Violence and Crime or the 400 Municipalities in the National Crusade Against Hunger. Support can be used for manufacturing infrastructure, equipment, and other categories.


123

4. NACIONAL FINANCIERA40 4.1 SME LOANS These are SME loans that can be used for working capital or the procurement of fixed assets. The benefits of loans vary depending in the financial intermediary approached by the beneficiary.

4.2 CARGO AND PASSENGER TRANSPORT MODERNIZATION PROGRAM This is a joint program, in collaboration with the Ministry of Communications and Transport, which was created to renew the federal cargo and passenger vehicle fleet nationwide through financing, junking and fast license plate registration. It is created for private individuals with entrepreneurial activities and corporations engaged in the federal cargo and passenger transportation industry. The Program’s users benefit by junking transport units aged over ten years, obtaining a fiscal stimulus on the deposit of a new unit, financing or new and semi-new units, entrepreneurial training, and access to new technologies and reductions in operating costs.

40 NAFIN program information was retrieved on November 5th, 2013, at: http://www.nafin.com/portalnf/content/ productos-y-servicios/programas-empresariales/ 124


4.3 PROGRAM TO SUPPORT SOFTWARE DEVELOPMENT COMPANIES AND RELATED SERVICES This is aimed at companies and private individuals with entrepreneurial activities engaged in software development and related services, including the outsourcing of software developers. This program provides working capital or the financing of fixed assets for amounts up to 3.5 million pesos. Guarantees and interest rates vary depending on loan type. Companies exclusively engaged in the sale and purchase of software are not eligible for the program.

4.4 STARTUP SEED CAPITAL CO-INVESTMENT FUND MEXICO This fund directly and indirectly promotes the availability of seed capital (early-stage investment, usually until a firm breaks even) for innovationdriven companies and entrepreneurs, with funds that go straight to equity or a supporting investment vehicle. Users of this product also benefit from new business partners and potential sources of financing. The program offers two schemes: one targeted at investment vehicles (Scheme A) and another for projects (Scheme B). Scheme A grants up to 50%

of the resources necessary into funds, business incubators, technology transfer offices and similar bodies, which contribute to the development of projects created from seed capital (although they do not actually generate the project). Whereas, Scheme B grants seed capital of between 100,000 and 5 million pesos (or 50% of required investment) directly to companies and entrepreneurs that already have 50% of the required investment, in order to begin the project. To access the appropriate funding scheme, investment vehicles must have a seed capital investment thesis, a clean credit history, experience and own funds. Whereas, projects and companies must have been in operation for at least one year and must not yet have reached their breakeven point.

4.5 CONSTRUCTION INDUSTRY FINANCING This program offers financial support to construction companies, with lines of credit allocated towards supporting working capital and the financing of fixed assets. This financing is available to private individuals with entrepreneurial activities and corporations engaged in construction activities with a positive credit bureau history and proven experience in construction project development. The line of credit amount can be up to 15 million dollars and must be allocated towards working capital and equipment.

5. SEDESOL41 5.1 PRODUCTIVE OPTIONS PROGRAM This

program

supports

economically

and

environmentally sustainable productive projects among the rural population with earnings below the poverty line by incorporating and developing productive and technical skills. This program includes some schemes that facilitate asset acquisition. The Integrative Projects scheme targeted at farmers’ organizations seeking to join

41 Source: http://www.sedesol.gob.mx/work/models/ SEDESOL/Programas_Sociales/OpcionesProductivas/convoca toria/FC_8_abril.pdf Retrieved on November 5th, 2013. TAX INCENTIVES FOR INVESTMENT AND THEIR IMPACT ON THE COMPETITIVENESS OF MEXICO

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the production chain, and the Co-financing Funds

invested in. The components considered are

scheme targeted at private individuals or groups

agriculture, livestock farming, fisheries, traditional

support various aspects of productive programs.

productive assets (machinery and equipment),

The amount of financial support depends on

protected agriculture (production of health and

where the project is developed and the sex of the

value-added foodstuffs), electrification of fish

beneficiaries, and between 80% and 95% of the

farms, fisheries and aquaculture infrastructure,

total project value can be provided as long as this

replacement of marine engines, post-production

does not exceed 5 million pesos under the first

management, fishing fleet modernization, genetic

scheme and 300,000 pesos under the second. All

resources, “social” mining (exploitation of non-

assets acquired using federal resources must be

metal minerals and rocks situated on public land

insured, subject to insurance company availability.

and in rural communities) and production branch development through total support.

6. SAGARPA42 6.1 SUPPORT FOR EQUIPMENT AND INFRASTRUCTURE INVESTMENT

6.2 PROCAMPO PRODUCTIVE A program to improve the incomes of agricultural, aquaculture

and

fish

farmers

with

direct

supplementary support for the modernization of machinery and equipment, and the acquisition of energy supplies. The program has three

This support seeks to increase the capitalization

components. The first of these is PROCAMPO

of economic units in agriculture, fisheries and

Productive,

aquaculture through supplementary financial

organizations engaged in farming, which have

support for investment in equipment and

registered estates, which keep the estate in use

infrastructure for primary production activities,

and satisfy the Program regulations. Amounts of

value adding processes, market access, and to

support reach 1,300 pesos per eligible rain-fed

support the construction and restoration of public

hectare during the Spring-Summer cycle, with

productive infrastructure for the common good.

a 100,000 peso limit on each individual during

Amounts of the financial support granted vary

each agricultural cycle. The second supports

based on the support type and the component

the modernization of agricultural machinery

for

private

individuals

and

belonging to individuals or corporations for the maximum support amounts established 42 SAGARPA program information was obtained from: http:// sagarpa.gob.mx/ProgramasSAGARPA/Paginas/default.aspx 126


in Article 25 of the Agreement announcing

the Operational Regulations for Programs of the Ministry of Agriculture, Livestock, Rural Development, Fisheries and Food), in accordance with the type of equipment and its use. The third component grants diesel and petrol subsidies for associated activities, and is mutually exclusive alongside machinery modernization.

6.3 NATURAL RESOURCES SUSTAINABILITY PROGRAM Support and services to develop sustainable works and practices that help encourage a new productive structure, such as crops for bioenergy production, sustainable energy use, use of alternative energy sources, and the conservation and sustainable use of the land, water and vegetation of productive units. It has several components, but those targeted at assets are the financial support for the procurement of assets that will be recognized as a share contribution by producers; investment in energy, high-efficiency water pumping systems, fruit and vegetable cooling chambers, etc.


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APPENDIX 5.

INTERNATIONAL TAX SIMPLIFICATION MEASURES Registration

Category

Recommendation

Status in Mexico

Remarks Currently, individuals who are over 18 and have a Unique Population Registration Code can register online with the Federal Taxpayers’

Personal taxpayer registration assistance

Yes

Registry. A registration support handbook is also provided; the SAT website has detailed information for each type of taxpayer and

programs and services.

some of the forms for the process can be downloaded. The tax administration system pre-fills

The tax reform contemplates the possibility that SAT will pre-fill the Yes

payment forms.

forms of taxpayers subject to the Incorporation Regime. However, most taxpayers do not have access to this facility. The tax reform has replaced the Intermediate Regime and the Regime for Small Enterprises (REPECO), which simplified SME tax

PAy

payments, with the Incorporation Regime, which only applies to private individuals who perform entrepreneurial activities, or who transfer goods or provide services, the practice of which does not

Implementation of special, simplified regimes for SMEs.

No

require a professional qualification, and who have annual salaries of up to 2 million pesos (LISR, 2014), under which circumstances only taxpayers under the REPECO regime may join up to the new tax Regime. In fact, in view of the NAFINSA classification, which establishes that a micro enterprise is one with less than ten workers and an annual turnover of less than four million pesos, SMEs are left under-served under this new scheme.

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Category

Recommendation

Status in Mexico

Remarks The SAT offers guidance over how to make monthly tax declarations

Preparation of tax payment handbooks.

for each type of taxpayer on the “Declarations and Payment Yes

Service (referenced payment)” section of its website. This includes handbooks, videos and assistance channels. The website even allows tax payable to be calculated.

Tax payment seminars

PAy

for SMEs. Online courses on different fiscal issues.

No

Collective guidance is given at fiscal talks and conferences, however, most of these are not targeted at SMEs.

Yes

Tutorials exist for the most common services and procedures.

No

Although the SAT website allows all taxpayers to calculate their taxes.

Development of software for managing SME tax accounting and declarations, and SME training in their use. Mass media dissemination of laws

“Tax Reform” section of the SAT website. There is also a “Regulations” section showing tax legislation in detail.

their amendments). Make information available on taxpayer rights and obligations, as well as the incentives for which

Partially

Taxpayer Interaction

and procedures (and

All amendments made to tax laws for each year can be viewed in the Yes

they are eligible, in

Information on taxpayer obligations can be found on various sections of the SAT website, however, the tax incentive eligibility is not made clear.

language that is easy to understand. Information leaflets

Yes

Information leaflets can only be obtained at SAT offices, since no electronic version exists.


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Category

Recommendation

Status in Mexico

The tax reform approved the creation of a Taxpayers’ mailbox,

Taxpayers’ mailbox (to send notifications,

Yes

requests, forms, etc.). Development of web

Taxpayer interaction

applications

whereby the tax authority can send digital notifications and requests, and can receive documentation and information from the taxpayer.

No

Helplines.

Yes

Regular newsletters.

No

Virtual mailbox for complaints

Remarks

Yes

and suggestions.

--As well as helplines (INFOSAT), you can receive guidance by instant messenger, email or at the customer service offices. On the SAT website, it is only possible to view some communiques and notifications. There are avenues for submitting complaints, suggestions, accusations and acknowledgments.

Create administrative offices for each type of taxpayer

No

Only offices to deal with large taxpayers exist.

No

The SAT website does not separate information by taxpayer type.

(individuals, SMEs and foreign nationals). Separate microsites for each taxpayer type. Dissemination of information

Yes

on social media.

The SAT has a Twitter and Facebook account where it makes relevant information available to taxpayers.

Opinion surveys to improve

No

---

customer service. Source: compiled privately based on information from (World Bank, 2009), (Ibarra, 2006), (OECD, 2010) and the SAT.

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ETHOS is a Think Tank that transforms researches and experiences into clear recommendations and specific public policy actions that serve to the most relevant problems and major challenges to the development and progress of Mexico and Latin America.


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