How Mexico's tax reforms could affect business along the border

President Peña Nieto's sweeping reforms raise taxes on US-owned companies and other businesses. Some firms along the US-Mexico border say they won't rule out relocating.

Expanding Atronix Inc., a Massachusetts-based company, to the border state of Sonora, Mexico, two decades ago proved to be a wise business decision for the manufacturer of electrical wiring systems.

The company has grown significantly since it took over an existing assembly plant here in 1994, says Jeffrey Lang, president of Atronix de México. "We went from 30 employees and less than 6,000 square feet to more than 230 employees and 45,000 square feet."

With the Nogales maquiladora, or factory, accounting for up to 70 percent of the company's annual production, Atronix wants to stay put in Mexico. But President Enrique Peña Nieto's proposed fiscal reforms, which Congress just passed in a modified package that raises taxes on US-owned companies and other businesses, has prompted Mr. Lang's company to consider relocation.

"If what had been originally proposed had passed, we would shut down this facility within 12 months," says Lang, referring to the first round of legislation that included now-discarded measures such as a second import tax for the factories.

The sweeping reforms, which seek to collect funds for social programs and road infrastructure, also raise taxes for high earners and levy a tax on junk food and stock market gains. Lawmakers considered adding a tax on food and medicine but dropped the contentious plan.

The fiscal overhaul is intended to help strengthen a low tax base that is further weakened by substantial levels of informal labor that fails to generate state revenue. As it awaits the president's signature, proponents laud Mexico's move as an important move toward revitalizing the economy and catapulting the country forward in terms of development and living standards.

But the tax increases are condemned along the US-Mexico border, where most of the country's maquiladoras, which operate in a tax-free zone, make everything from television sets to clothing and medical devices. With these reforms, Mexico also wants to discourage the importation of tax-free materials that are sold in Mexico rather than shipped out of the country as a final product.

In some ways, Lang says, he understands why the government deems the changes necessary to eliminate businesses cheating the system, "ones that are not necessarily responsible commercial or business entities in Mexico."

On the other hand, if the fiscal reforms negatively affect his company's bottom line, he won't hesitate to pull up stakes. "If this creates a situation where I can no longer be competitive producing here in Mexico, I would find a more competitive location," Lang says.

No more preferential treatment?

The industry has lobbied hard against the tax-reform package: Factories have received preferential tariff treatment in Mexico since the 1960s, when the country opened its doors to foreign-owned factories that import components for assembly and then export them as finished products. Tax breaks, coupled with the allure of cheaper labor and lower production costs, began attracting mostly American manufacturers to border cities. In 2007, the last year Mexico published statistics unique to such factories, the number of  assembly plants in the country totaled about 2,800.

Under the law, formerly exempt maquiladoras must pay a 16-percent sales tax known here as the value-added tax, or IVA, on goods imported for assembly and subsequent exportation. Although the tax is reimbursable, industry opponents say it poses a cash flow hardship and increases bureaucracy. The industry averted another proposed tax of 16 percent on the temporary import of raw materials.

The new rules also mean a hike in the retail sales tax along the border, to 16 percent from 11 percent. The region had enjoyed a low tax rate for years, intended to draw business here and increase competitiveness with US cities. Once the increase takes effect Jan. 1, 2014, all of Mexico will pay the same rate.

The maquiladora-specific tax won't go into effect until the government establishes certification rules, presumably by January 2015, says Alejandro Brugués, an economic analyst at the Ciudad Juárez campus of the Colegio de la Frontera Norte, a Mexico think tank.

To be eligible, each company will have to be certified under a new system that has yet to be established, Mr. Brugués says. The reforms also affect the corporate income tax rate, which increases from 17.5 percent to more than 30 percent, he adds.

But Mexico still needs to define how the new rules will be implemented, and until then, uncertainty over the changes will persist, says Richard Rubin, who sits on the maquiladora association board in Nogales.

The industry, which is rebounding from a jobs decline and manufacturing losses to China in recent years, is key to Mexico's economic well-being, only second to oil, Mr. Rubin notes. "Mexico would be crazy to destroy the maquila industry."

Wiggle room

Atronix's Lang won't say how much he pays his employees, but notes his company strives to build a positive workplace. Perks include free breakfast and lunch during the 48-hour workweek, where women and men assemble cables and wires for medical equipment and other uses.

The company's turnover rate is less than 3 percent, Lang says, which is considered low in the industry. "Our average employee has been with us for more than six years; more than half of our employees have been with us for more than 10 years."

He, like many in his industry, is taking a wait-and-see attitude on how the fiscal reforms play out.

Despite Mexico's new law, the country is still attractive to many foreign companies, says Gordon Hanson, professor of economics at the University of California, San Diego. Places like China, Bangladesh, and Indonesia may offer cheaper labor, but Mexico's proximity to the United States gives it an edge as an ideal location for many US manufacturers, he adds.

"That might give Mexico some cushion in terms of being able to raise tax rates without scaring off employers."

'Boom' on the border

Along the border, foreign-owned companies, most of them from the United States, have propelled the growth of the manufacturing industry since the first few maquiladoras launched operations. The industry now provides some 60 percent of jobs in the region, Brugués says.

In April 2012, Mexico's maquiladoras and other manufacturing companies totaled 5,075 and provided 1.9 million jobs, according to a report by the Congressional Research Service, an arm of the US Congress.

In Nogales, more than 100 factories employ about 34,000 people, according to a University of Arizona report released in September. Researchers also note the industry benefits adjoining Santa Cruz County just over the Arizona border, including the creation of 10 percent of jobs in that city.

The maquiladora industry took off in the early 1980s after Mexico, seeking to generate more export revenue in the midst of a debt crisis, streamlined the rules governing maquiladoras.

The country's economy was "still pretty closed" to the rest of the world, with much of its manufacturing capacity in and around Mexico City, Professor Hanson says. That scenario changed drastically by the mid-1990s, after the North American Free Trade Agreement took effect.

"As Mexico opened itself up to the rest of the world, all of a sudden the big market in the neighborhood was not central Mexico, it was the US," he says. "And that led to the industrialization of the border."

The boom in the industry had a profound impact.

"It raised income, it dramatically expanded the size of those cities, it brought people to the border from all over Mexico," Hanson adds. "It created economic opportunities for women that had never existed before. "

It also brought social disruption. In border cities crowded with factory workers, common complaints include a lack of affordable housing, low worker wages, and labor rights abuses.

And despite the industry's economic successes, at times it has been linked to a dark side. In the 1990s and early 2000s, numerous young women who worked at maquiladoras in Juárez were being kidnapped, raped, and murdered.

Violence associated with Mexico's 7-year drug war is largely blamed for a tourism drop in Mexico's border cities. The number of visitors to the region fell 5.3 percent in 2012, according to tourism department data.

In Nogales, the absence of tourists makes the presence of maquiladoras even more apparent. The myriad souvenir shops and restaurants that once catered to mostly Americans just a few blocks south of the border are now medical offices. The downtown streets, once congested with visitors, are rather quiet. But farther south, near the city's industrial clusters, the streets vibrate with activity. Workers come and go, nearby shops bustle with customers and local buses roll past jam-packed with passengers.

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