The taxing of Mezcal – are changes afoot?

You’ve probably heard it mentioned before that taxes on mezcal are very high but in Mexico, they’re astronomical. There are two different taxes levied on alcohol, the Impuesto Especial en Productos y Servicios or IEPS, puts a 53% tax on the cost of of any alcohol product with an alcohol grade greater than 20%, and the VAT, or sales tax which puts 16% on the final sale price, a price that includes the cost of the taxes factored back in. This essentially means taxes can end up being more than 70% for alcohol in Mexico.

But all alcohol taxes are not equal: There are three different tiers depending on ABV, 26.5% on products with up to 14%, 30% on products with 14-20%, and 53% on anything greater than 20%. Additionally, the cheaper the production cost, the lower the impact the IEPS tax has on the final product cost. Non-industrial spirits, like mezcal which use expensive ingredients and are labor intensive, have a much higher production cost than beer so these taxes have a greater impact. This is an underlying reason why so much mezcal is exported to the U.S. – brands can skip that 53% tax, and only pay the VAT.

The taxing details

There are very solid reasons to tax alcohol at a high rate, the primary being curtailing over consumption. Because the current alcohol tax system is an ad-valorum tax, or a tax on the production cost, it encourages companies to lower their production costs. This often means greater industrialization, a move to cheaper inputs, resulting in a lower quality or more commoditized product. It has not meant curbing consumption. A new proposal by Iván Arturo Pérez Negrón Ruiz, Federal Deputy for Michoacan, would replace the ad-valorum tax with an ad-quantum tax that taxes the percentage of alcohol instead of the production cost of the product. The thought is that this form of taxation would better address concerns around alcohol consumption and would level the playing field between low cost and high cost alcohol producers. How the actual tax is calculated is a little more complicated. It is based on the Unidad de Medida y Actualización or UMA which is used to calculate taxes based on various economic measures..

La UMA es la unidad de cuenta, índice, base, medida o referencia económica en pesos para
determinar la cuantía del pago de las obligaciones y supuestos previstos en las leyes federales,
de las entidades federativas, así como en las disposiciones jurídicas que emanen de todas las
anteriores.

Each year, the UMA is set to a peso value. For 2020, the UMA has been valued at 86.88 pesos. One liter of pure alcohol equals 1.75 UMAs., therefore it’s valued at 152.04 pesos for taxation purposes. If it has an alcohol grade of 48%, the ad-quantum tax would be 72.98 pesos (152.04x.48). Under current ad-valorum tax rules, if that liter cost 200 pesos to produce, the tax would be 106 pesos, a 33.02 peso difference. This system of taxes would make it easier for high value alcohol companies to compete in the market by lowering the overall tax impact for them, and therefore the sales price for consumers.

In addition to leveling the playing field with an ad-quantam tax, the hope is this would discourage production practices that rely on cheap inputs and production practices. That includes chemical additives, grain or sugar cane based alcohols, and more. If you have spent time in Mexico you’ve likely seen them readily available in stores like OXXO, the most recognized being Tonayan which is known as the cheapest alcohol in Mexico and pretty much the biggest bang for the peso if you are looking to get drunk. The proposed legislation explicitly states its goal to penalize producers like that while not explicitly singling them out by name.

The proposed legislation addresses concerns about a decrease in tax revenue collection by saying that with new tax structure it is thought that approximately 33,000 million (or 33 billion) pesos more will be generated..

A move to help formalize the informal market?

In a 2019 study on the Mexican economy, it was estimated that about 30% of the country’s GDP is from the informal market which is composed of unregistered businesses like street vendors who sell food, water, artisan goods, batteries, and the like. Roughly 52% of Mexico’s population work in this informal market. Since it isn’t taxed, it puts a greater tax burden on registered businesses. The numbers have only increased due to the impact of the Coronavirus on Mexico’s economy, with an estimated 12 million people losing jobs and moving into the informal economy. This pressure is especially acute because Mexico does not have any unemployment insurance.

This extends to the mezcal world when producers sell their products to private clients, direct to their communities or to another producer or brand who has a registered business and who will then pay the tax. It used to be common practice in bars and restaurants in Oaxaca and elsewhere for there to be garrafones of house mezcales on the shelves. But about 6-7 years ago, regulators began clamping down on this practice – not because product wasn’t certified, but because it was unclear who was paying the IEPS tax. If you could not show that the taxes had been paid, you were closed down. This is why you now see branded bottles on shelves, and why the price of mezcal has gone up so much.

The informal market also opens itself to pressures of crime and corruption whether through lack of regulation, more counterfeit money being passed around, extortion or protection payments. Perhaps the biggest impact is in blending where someone mixes small batches from many small producers and bottles it under a brand name. A different tax structure could make it easier and more attractive for smaller producers to become legal businesses which might increase income while also eroding the problems associated with a large informal market.

At time when Mexico’s economy is projected to decline by 10% this year, and with a growing informal economy that pays no taxes, the ad-quantum structure might be especially appealing to the current government. For its part, the CRM has thrown its support behind the proposed legislation. In its estimation, it lessens the tax burden on producers, helps make mezcal more competitive in the domestic market, and could help more producers formalize their businesses and certify their products if they are in the DO. Ultimately the success or failure of this bill will rely on getting the behemoth beer industry on board. In the meantime, we’ll keep an eye on the progress.