Maquiladoras, or manufacturers in Mexico focused on exports, were on a roll this year. Barely a week went by without a major shipper announcing its plans to set up shop or expand operations in Mexico. The accessibility to the largest global market, the United States; rising Chinese labor costs; and higher transportation costs are forging Mexico into a Latin American manufacturing powerhouse, proponents argue.
Then the government stepped in. Through a $14 billion tax plan, maquiladoras face a value added tax of 16 percent that kicks in 2015 and an income tax rise from 17.5 percent to 30 percent, starting next year. The phasing out of tax incentives — ranging from tax-exempt food credit for workers to housing subsidies — will bring the income tax for maquiladoras up to 38 percent, said Luis Hernandez, president of Index Nuevo Laredo, a coalition of maquiladoras in the region.
“I think there will be casualties in 2014,” he said. “I don’t think the government realized what it did.”
The country’s roughly 6,000 maquiladoras — many of them in the automotive industry — export about $200 billion in goods annually and employ about 2.3 million people, Hernandez said, citing National Maquiladora Council statistics. Between 80 percent to 85 percent of maquildoras' exports head to the U.S. He estimates the tax overhaul could ultimately reduce the number of maquiladoras, employment and exports by 15 percent.
Mexican companies won’t be able to absorb the additional costs, raising the value of product and spurring some to shift production to China, Central America or the Caribbean, he said. Others such as the major automakers, including Honda, Nissan and Ford, are unlikely to pack it up, as they have made major capital investments and still enjoy good access to American consumers.
The tax overhaul, which has drawn the ire across business sector from miners to soda producers, is part of the government’s effort to close tax loopholes and wean the country off its dependence of oil revenue, said Christopher Wilson, an associate at the Woodrow Wilson Center’s Mexico Institute. He said the VAT is aimed at cracking down on manufacturers that pose as maquiladoras but don’t actually export their products.
But Mexican businesses are calling foul on the approach because the plan raises taxes on companies already paying taxes, not the black market economy legislators want to rein in, said Erik Markeset, principal and founder of logistics consulting firm Tsol in Mexico City. Instead, maquiladoras, many of which already face financing challenges, face a cash crunch as they won’t get back the VAT they pay on imported machinery and raw materials until they export their final products, said Mark Earley, chief financial officer at Tecma Group, an El Paso, Texas-based consulting company that helps manufacturers do business in Mexico.
The 16 manufacturers Tecma aids import about $400 million in production inputs annually, meaning they will have to pay about $64 million in VAT. It could take up six months for manufacturer to get the VAT back through exports, meaning the 16 manufacturers could have about $32 million less in cash total until then.
“Investment in Mexico is slowing down,” Earley said. “A lot of people are waiting on the sidelines to see how (the tax overhaul works out). We may see companies move out of Mexico and go to Central America and the Caribbean. This could be a maquila killer.”
President Enrique Pena Nieto expects Mexico to attract a record amount of more than $35 billion in foreign direct investment this year, according to Reuters. Investors poured in nearly $24 billion in the first half, putting the country on track to beat its record pull of $31.5 billion in 2007. The International Monetary Fund in early October reduced its 2013 growth outlook for the country from 2.9 percent to 1.9 percent.
There could be some VAT relief for some maquiladoras, as the Mexican Senate has passed legislation that would allow some shippers to get certified so they could be exempt from the VAT, Hernandez said. There is talk that about 100 companies could be certified, but which manufacturers would be eligible isn’t yet known. The certification program will likely be available to the largest manufacturers and that won’t do anything for the smaller companies that struggle with cash flow the most. Plus, even certification participants will still have to pay administrative fees, Hernandez said.
The tax overhaul could encourage maquiladoras to mature their supply chains, as companies that only add minimal value to products before exporting them would see less advantages of doing so, Wilson said. Although the tax overhaul is disappointing to the business community, the potential trade-off is the liberalization of Pemex, the state monopoly, Markeset said.
Under the plan, foreign drillers will be able to tap oil reserves off the coast, potentially ending a nearly 30-year dry spell of offshore exploration. The liberalization is also aimed at expanding the production of natural gas, much like Mexico’s most northern neighbor has done. The question is whether the government will use the additional tax revenue to support business through better education and infrastructure.
To keep its competitive edge, particularly as its grapples with rising taxes, maquiladoras need better transportation infrastructure, a more skilled labor force and a wider sourcing base. Nieto has signaled the importance of spending on freight corridors, particularly links to the U.S., but a detailed plan has yet to emerge, Wilson said. Mexico trumpets that it pumps out roughly 130,000 engineers every year, but they aren’t the same quality as those graduating from German and American schools. Mexico needs more engineers that can create products, rather than manage factory floors, he said. The expansion of the sourcing base is key to competing with China, and that will require giving manufacturers better access to financing.
There is still some hope that Mexican businesses can lobby the government to soften the tax overhaul. Without major changes, though, the tax plan is a stiff shot urging bold investment and innovation — unless the industry wants to risk a maquila sunset.