By Alberto Barreix and Luiz Villela ¹

1. Executive Summary

The last quarter of the 20th century saw unprecedented standardization in the structure of tax systems as a result of structural adjustments in developing countries followed by the abandonment of command-and-control economies. However, this has not been accompanied by equalization of the management capacities of their administrations. The reshaping of our region’s tax map was influenced first by the trade and financial liberalizations of the mid 70s and then by the need for greater fiscal discipline imposed by the structural adjustments following the first debt crisis.

Subregional trade integration processes were also strengthened on the continent in the 90s, especially in Latin America and the Caribbean and, at the same time, these groups of countries have begun to align their monetary and exchange policies, in particular with the United States in our hemisphere. These processes of trade and financial liberalization, integration, and monetary and exchange alignment have not been accompanied by parallel efforts at coordinating the international aspects of tax policy and administration that constitute the last bastion of economic sovereignty at both the national level and the level of subnational governments. By contrast, in tax matters, there has been a marked trend toward competition to maintain and attract savings and investment, both domestic and foreign, using a wide range of incentives, often without consideration of their effects on economic efficiency and equity. While multilateral organizations such as the European Union (EU) and the Organization for Economic Cooperation and Development (OECD) have made efforts towards more effective control in recent years, fairer competition and distribution of the revenues from international activities has not been achieved, nor have the conditions for institutionalizing international cooperation in tax policy and administration.

The purpose of this paper is to present the major issues along with certain reflections on the tax matters that will undoubtedly affect the economic integration process.

2. Background

The Latin American and Caribbean tax systems were established during the 70s and 80s when most of the countries had fully implemented the import substitution model and had just begun early processes of trade and financial liberalization. Given that economic conditions have changed significantly over the past twenty-five years, these systems do not effectively promote either trade or investment.

Until the late 50s, most countries in the region were essentially focussed on agricultural and mining exports in which most tax revenues were generated by customs. Domestic taxation was essentially indirect—based on sales tax, selective excise on consumption and certain user taxes—with minimal revenues coming from direct taxes (income and real estate).

During the 60s, under the doctrine of import substitution industrialization developed by ECLAC in the 50s, fiscal policy began to make extensive use of taxation as a development tool. Tariff policy thus granted sectoral protection to domestic added value in a discretionary manner, the use of tax incentives increased and some countries developed a new tax on real estate—especially land—as well as on personal income tax using high marginal rates for the highest incomes.

1. Main characteristics of the reforms in the 70s and 80s. 

The most significant tax reforms of the century were carried out in the 70s and early 80s, alongside and in support of the early foreign trade and financial liberalization processes. The main characteristics of these structural changes were:

1. Simplification of tax systems through reduction of the number of taxes.
2. Review of the scattered legislation in tax matters and its arrangement into comprehensive codes.
3. Modernization of the tax administration.
4. Introduction of the value-added tax (VAT).
5. Introduction of a global, progressive personal income tax to replace systems that taxed income in a scheduled fashion by type of income.

Despite the introduction of modern tax policy instruments such as the VAT and global taxation of income, the proliferation of sectoral tax incentives and tax waivers, rampant inflation caused by the monetization of chronic tax deficits and poor administration led to the deterioration of tax systems and constant adjustments—wrongly dubbed reforms—that eroded collection bases and their quality in terms of efficiency and equity.

2. The fiscal and debt crisis of the 80s; the priority of sufficiency over efficiency and equity of the tax system

In the early 80s, the fiscal outlook of the southern part of the hemisphere was clouded by the fiscal, exchange and debt crises. A process of continuous tax adjustments with the fiscalist objective of sufficiency—increasing tax revenues—began to detract from the efficiency and equity of the systems. This was based on the perception that growing tax deficits caused by heavy spending, including debt servicing, produced high inflationary taxes that were not only unfair but that fostered uncertainty with respect to decisions on savings and investment. This led to a domination of indirect taxation, with some taxes having a cascading effect (tax on tax) that weakened the quality of the tax structures in place.

Alongside these reforms, in the late 80s, priority began to be placed on modernizing tax administrations, based on the view that a system is only as good as its administration. This led to a greater priorization of mechanisms such as the proliferation of tax withholding mechanisms as well as a series of training programs, establishment of major taxpayer units, etc., that affected the quality of the systems even more. Despite this, there were substantive improvements with respect to information technology, professionalization of institutions and the granting of technical and budgetary independence to tax administrations.

3. The Washington Consensus, the New Regionalism and the need for modernization of tax systems

A significant factor that drove many of the adjustments in the region during the 90s fell under the framework of the so-called Washington Consensus, which sought to strengthen market functioning reforms through complementary, second-generation reforms to trade and financial liberalization, such as privatizations and concessions, regulations, institutional reform of the public sector and of control in the financial sector, etc.

In matters of taxation, the Washington Consensus did not have a high impact except for a greater tendency to encourage foreign investment—through legislation on incentives—and trade as well as guarantees for activities expressed in general in the updating of the Tax Codes.

With respect to regional trade agreements, ever since their struggles for independence, the countries of Latin America had been making efforts towards political and economic integration. Those efforts were strengthened in the post-war period and centred on the creation of free trade areas though within the framework of import substitution industrialization, given that the domestic markets were small in some countries and that this would be a means of achieving regional markets with economies of scale and agglomeration. These markets would be protected by differential tariffs between the partners with relative increases in the barriers to imports from countries outside the region, and would maintain an important presence of the public sector in the economy.

However, the presence of the so-called New Regionalism has been observed in the region since the early 90s. This process seeks to increase regional economic integration but in step with unilateral or multilateral liberalization. The influence of the Uruguay Round and World Trade Organization (WTO) agreements was an integral part of this structural move of foreign trade policy towards more open market-oriented policies within the free exercise of democracy. An example of this type of agreement is the NAFTA, which differs from MERCOSUR in that it includes both developing and developed partners.

Another characteristic is that the vast majority of Latin American and Caribbean countries have approved the WTO agreements and are therefore complying with them. However, many tax changes resulting from those agreements, such as the elimination of preferential systems and other income tax incentives in exclusive export activities under the Subsidies Agreement, have not been taken into account nor even considered. The “tariffication” of all barriers to trade, at least in the sectors covered by agreements, and their subsequent reduction will significantly affect countries that depend on tax revenues from foreign trade. Liberalization has in turn exponentially increased transactions between inter-related companies that, due to avoidance actions and harmful tax competition between jurisdictions, prevent countries from obtaining their fair share of the revenues generated, among other problems.

Graph 1

There are also strong discrepancies between the tax burdens of each country in the region as observed in Graph 2.

• Graph 2

Above and beyond the technical difficulties related to the representativity of the years compared or technical issues such as the inclusion of social security contributions (with today’s participation of privately-administered actuarial systems rather than pay-as-you-go and generational solidarity mechanisms managed solely by the State) or royalties on natural resources (which are also intergenerational transfer mechanisms), we can observe the strong dispersion of the fiscal effort.

In short, two decades of increasing trade and competition on the international market will lead to new fiscal efforts that will inevitably force countries to adjust their tax systems, which are already under heavy pressure from increased social and infrastructure spending that must also be managed more efficiently and with greater participation by the private sector and civil society in general. These new reforms will have the a priori contradictory objectives of generating sufficient (higher) tax revenues while at the same time increasing their competitiveness with respect to their partners. In the past, reforms favoured increasing resources at the expense of economic distortions that affect the productivity and fairness of countries through their impact on the legitimacy and commitment to the market economy and democracy itself. The new reforms must priorize competitiveness for the regional and global market together with a fiscal policy of focused revenues and expenditures that helps satisfy and maintain a certain vertical equity in the distribution of revenues to ensure ongoing support of the market economy and democracy itself.       

3. Effects of Trade and Financial Liberalization and of Economic Integration on Taxation

Tax policy is an important factor in international trade and finances, not just in the domestic economy, due to:

• The importance of taxes on imports and exports;
• The fact that taxes can be obstacles to international trade and to investment, or can help to create a good climate for them; and
• The fact that one country’s taxes may affect other countries.

Similarly, trade and financial liberalization affect a country’s tax policy in terms of both tariffs and domestic taxes.

1. Tax effects of trade liberalization

During the last quarter-century, Latin America and the Caribbean saw significant changes to their economic structure. The processes of trade and financial liberalization that developed at different speeds around the world were applied in the region. This boosted productivity and led to greater specialization, increased investment in dynamic sectors and economic growth.

At the same time, there were costs incurred, due in part to errors in the implementation of policy changes. The heavy reduction of average rates and the dispersion of tariffs, reducing effective protection, have limited sectoral policies—especially in the manufacturing sector—and, as a result, lowered the revenues of the protected sectors. One result of this has been that as the combined value of the protected sectors decreases, so too do revenues from income tax and social security contributions. A second consequence is that to alleviate these effects, there has been heavy pressure for new incentives and tax benefits to protect sectors or regions, resulting in sizeable tax waivers that affect both public funds and the efficiency of their administration.

Thirdly, trade liberalization when the conditions of equalization of the value of products and inputs at the international level are met (Hecksher and Ohlin) and specialization in sectors with relative comparative advantages is favoured [sic]. In our countries, this translates into the growth of primary products (agricultural products and non-renewable natural resources) and a decreased share for the manufacturing sector. In addition, other trends such as the tertiarization of services by increasing the number of microenterprises and small and medium-sized businesses generate a new distribution of added value at the level of the three major economic sectors as shown in Table 1. As can be observed, while the region has lost more than 11% of its industrial product, it has seen 14% growth in services over the course of two decades.

This has significant consequences, especially for tax policy and, above all, administration, since the largest group of taxpayers consists of those who are “difficult to tax” (Shome, 1999). This phenomenon could likely have been partially offset by growth in the concentration of economic activity. In most countries in the region, 75% of total tax revenues comes from less than 1% of all taxpayers.

Last but not least, it is important to note that trade liberalization and specialization in primary products is accompanied by a high degree of price variation, thus increasing the volatility of export revenues and hence, levels of domestic economic activity and tax collection.

2. Tax effects of financial liberalization

The liberalization of capital flows accompanied by the development of telecommunications and new investment instruments has increased the movement of capital into and out of countries. In this way, Latin America’s markets have become at least partially incorporated into the world’s financial architecture, gained access to new and more efficient sources of credit, and provided greater opportunities for domestic savings. As with trade liberalization, this also caused problems that were mainly due to errors in the processes and sequence of implementation. In fact, the elimination of exchange controls, capital flows and the development of new instruments give great relative mobility to financial capital. For example, in the year 2000, trade flows of goods and services amounted to $7.5 billion while international capital flows were five times that amount. The competition between countries to attract capital results in a race to lower taxes to reduce the capital cost of the investments as well as to retain domestic savings and attract savings from abroad.

In addition, more sophisticated mechanisms for fiscal planning of the financial structure (for example, substituting dividends for interest where the former are not taxed) combined with the new financial products (derivatives and other similar instruments) offer greater opportunities for tax arbitrage and heighten erosion of the income tax base (tax degradation). Increased transactions between affiliated or connected companies in different countries have given rise to transfer pricing in an effort to avoid the taxman and reduce income tax payments.

In addition, highly qualified professionals, who generate value in a knowledge-based economy, are becoming more sensitive to the differential tax rates on their income and consider them an important factor in their decisions to emigrate.

Capital volatility and the use of fiscal planning through instruments such as "financial centres", off-shore, hedge-funds and intra-company transactions have led to competition between jurisdictions to reduce the tax burden so as to retain and attract savings, which has resulted in a further degradation of tax systems. In fact, this generates competition between countries to attract capital that results in a race to lower taxes to reduce the cost of the capital and hence retain domestic savings and attract foreign ones.

In conclusion, the liberalization of trade and capital flows has a clear potential to substantially increase the well-being of the countries but also poses challenges for their governments as it erodes the income and foreign trade tax bases that were offset by increases in consumption and payroll taxation in Latin America. In addition, the proliferation of tax incentives on investment, as well as the urgent need to boost revenues by grasping at saturated tax bases and with few opportunities for evasion thereby creating inefficient taxes that heavily affect economic efficiency, such as the cheque tax, sales tax (that generates a tax on a tax) or tax on gross wages have weakened the quality of the tax systems in Latin America and the Caribbean.

4. Main Tax Challenges of Economic Integration

1. Relations of trade and tax policy in a regional integration process

During the last quarter of the century, the countries of Latin America and the Caribbean began a process of economic liberalization and, as part of this process, adopted regional integration as an additional policy tool—not a goal but a means of promoting economic growth. The rationale behind this policy is that as countries increase their international trade, their economies are able achieve greater levels of productivity and well-being. Opening the door to goods, services and investments from abroad helps countries gain access to better and cheaper inputs, and the ability to export to expanded markets generates economies of scale in domestic production.

Economic integration has created opportunities for the economies of the countries, but there are challenges associated with this process. The countries are finding that their economic decisions are increasingly limited by actions and events that take place outside their borders, and this is true as much for small countries as for the large ones.

Despite the integration of economic policies, the nations continue their efforts to protect their political sovereignty and to maintain their capacity to determine their own economic destiny. These conflicting trends are being gradually resolved. International coordination mechanisms remain weak, and this is most evident in taxation, which is one of the fundamental principles of representative democracy. For example, in the most advanced regional integration process, the European Union (EU), a monetary union has been achieved but significant tax harmonization has not, and each country maintains its sovereign policy in that regard (see Annex 1).

The boundaries between trade policy and tax policy are disappearing. At present, trade and regional integration negotiators are realizing that trade promotion will require special attention to the economic effects of taxes. Tax specialists agree that tax systems may contain hidden subsidies and barriers to international trade in goods, services and capital, as recognized by the World Trade Organization (WTO) itself and the Organization for Economic Cooperation and Development (OECD). Moreover, the greater the macroeconomic coordination that complements the trade integration, such as single (as with the EU) or harmonized monetary and exchange policies, or even in other aspects such as regulation of domestic markets, the more important the tax component becomes. It can become a major factor in the allocation of resources and investments between partners and even within the countries at the subnational level.

While there is a perceived need for international coordination in this tax matter to support the growing trade integration, the reluctance of the countries to surrender what we might refer to as the last bastion of sovereignty (tax and fiscal, in general) has restricted progress in the institutionality of international tax matters and obstructed the creation of supranational taxation entities. However, efforts are beginning to be seen in matters of tax coordination in some multilateral institutions both in the realm of integration processes such as the EU, as well as at a more global level, such as the OECD.

More specifically, economic interdependence has profound implications on tax matters, especially in three areas:

1. The strong increase in the mobility of factors, particularly the capital factor, is becoming quite sensitive to differences in tax treatment that affect tax bases.
2. The growing difficulty in assessing and collecting taxes on activities carried out outside the jurisdiction of the country, especially in the case of intangible assets.
3. The increased complexity of the tax administration process that demands new tools and an increasingly higher level of information for tax collection, which requires broad cooperation between jurisdictions.

In conclusion, as economies become more integrated, taxation plays a more important role in the overall strategies of businesses. Differences in legislation and in tax administrations (structures, bases, rates, compliance, due process, and treaties) are increasingly important and can result in avoidance or evasion. The reaction of governments can lead to competition and tax degradation.  This poses the challenge of how governments will respond to the need to balance the growing economic integration process on the one hand with the direction of their domestic tax policies on the other.

The growing interdependence between national economies generates less tolerance for divergence between national policies and hence, the need for greater international cooperation. In particular, in tax matters, the potential conflict between greater transnational economic activity and the desire to maintain flexible economic policies has created tension among policymakers.

With globalization and economic integration, it is becoming very difficult to separate domestic policies from international policies, as was the case in the past when trade policy fell under the latter category and social and tax policies under the former. At present, a country’s domestic policies have effects on other countries, and also suffer from the restrictions imposed by other countries. For example, when the United States unilaterally abolished deductions at the source on the interest income of non-residents in 1984, because there were no mechanisms for the exchange of information, it is estimated that some US$300 billion exited Latin America for bank accounts and other forms of portfolio investment in the U.S., (although we must also ask what percentage of those funds was American capital that had "fled" the country to reap the tax advantages of Latin America). Real investment flows are also affected by the tax incentive policies implemented by some countries as well as by those of subnational governments, as in the case of Brazil, that have affected the investment decisions of other countries.

2. The Main Impacts of Economic Integration (Common Topics on the Agenda)

We can identify a series of impacts that must be considered in parallel with trade agreements to ensure the stability and legitimacy of those agreements and of the economy in general to guarantee a sustainable, efficient and equitable fiscal policy.

1. The tax revenues substitution process

The first impact of integration is reduced revenues from tariffs generated by trade between partners. Table 2 shows us the different effects the FTAA would have in the subregions of the hemisphere. It is important to take into account that methodologically speaking, while the loss of tax resources is evident, the comparative static analysis, current situation with changes, will not necessarily be the effect generated. For example, it is possible that the diversion of trade, the replacement of imports from outside the region with intra-regional ones, worsens the problem, but increased trade between partners will also generate higher revenues that are reflected in other economic aggregates that also constitute bases for other taxes. For example, an exponential increase such as that of trade between Mexico and its NAFTA partners can generate a strong increase in investment and consumption that in turn translates into increased revenues from the VAT or income tax if a series of problems that ensure this substitution are resolved.

Other countries, especially in the Caribbean, have tariff systems resulting from their inherited Anglo-Saxon tax structures, which, because there is no national production, can be easily replaced with consumption excise taxes (as in the case of the study for Belize by Jenkins and Kuo).  

• Table 2

At the same time, it is important to point out that there is no country in the region with tax surpluses and that, for example, the relative losses of revenue can be significant above and beyond the percentage of the tax burden they represent.

For example, MERCOSUR currently has tax deficits of close to 4% of its GDP and its debt servicing more than doubled due to the effects of the devaluations, wherefore even 0.4%--which would now be almost doubled as they are tied to imports that are maintained in dollars unlike national revenues—of the GDP in lost tax revenues due to the recession can become a serious obstacle.  Something of the sort is taking place in Central America, where the average tax burden is close to 12%², which means that the tax gap could reach destabilizing proportions. Something similar is also taking place in the Andean Community of Nations.

For example, Table 3 depicts discrepancies in the fiscal impact of the FTAA for a relatively uniform region such as the Central American Common Market (MCCA), which in turn is the subregion with the greatest exchange measured both in terms of the GDP and foreign trade.

It must also be recognized that there are losers in the integration process, not all of them irrecoverable—which are those that only survive by means of very expensive effective protection that weighs heavily on the rest of the society, which must consume at prices much higher than international ones—that must be offset through higher tax spending that encourages the transition and legitimacy of the process.

In any case, it is important to note that the region has already experienced this phenomenon in the unilateral liberalization of its foreign trade and that in the end, with planned structural reforms that replace tariff revenues with both direct and indirect taxes, that ensure medium and long-term fiscal stability.

2. The System for Promotion of Exports (Export Processing Zones) and Investments (Tax Wars)

This is a crucial point because many of these special tax systems for exports of manufactured goods that generated heavy direct foreign investment in zones which, almost exclusively, produce for export and have income tax exemptions, originated in preferential trade systems such as quotas and special bilateral systems³ that were granted and promoted by the developed countries around the world.  Due to the fact that these exclusive export exemption systems must disappear according to phases set out in the agreements of the Uruguay and Doha Rounds, they will lead to a general reduction in taxes with the subsequent loss of tax revenues or exposure of the country to international punitive, monetary sanctions for the use of non-permitted (actionable) subsidies. Both results have devastating effects in terms of sufficiency due to loss of resources as well as horizontal equity of the systems since this basically amounts to a waiver of taxes on capital remuneration.

It is therefore necessary, respecting the agreements of the WTO in the Uruguay Round confirmed in the Doha Round, to consider how to dismantle these benefits without devastating effects on economic activity, exports and employment in the nations enjoying these benefits based on trade-limiting practices such as quotas and the preferential systems of the developed economies.

In our opinion, an analysis of the disloyal preferential treatment of investments should also be included, as this has the greatest effect on developing countries in a wide variety of forms, from customs-free areas to special subsidy systems that are often barely transparent in much of the world: Latin America and the Caribbean are no exception.

Lastly, it is difficult to separate and, hence, to negotiate, trade changes such as preferential trade systems without including parallel international tax agreements that ensure the transition and fairness of the trade integration. The NAFTA arrangements between Mexico and the U.S. for the treatment of maquila activities thus constitute a very positive precedent for the solution of this tax change under the framework of regional trade agreements.

Similarly, efforts must be coordinated regarding how to tax and exchange information on investment and direct foreign savings. For investments, agreements must be reached between jurisdictions—sometimes subnational—to avoid tax wars that end in a race towards zero in income tax collection and even subsidies that affect tax receipts. In capturing foreign savings, the absorption of foreign funds through concealment of bases that affect public funds of the investors’ countries of residence, which affects all countries without exception, must be prevented. This must be achieved through coordinating tax bases and exchanging tax information between national administrations, without obviating the freedom of each country to fix tax rates that avoid the rise of Leviathan states. 

3. Administrative coordination for equitable distribution of tax bases for income derived from international activities of related companies.

Globalization creates multinational companies that have greater economic power, information and technical tax capacity than many nations. Furthermore, the concentration of knowledge and scientific advances leads to distribution of the different phases of production to different countries among related companies that carry out activities where opposition interests do not exist. Something similar happens at the regional level. This is how tax planning tends to allocate income that does not correspond to the economic reality. Additionally, the concentration of financial capital in a few stock markets in developed countries results in the increased value of companies, sometimes a consequence of the minimization of international tax payments, which are only captured by the developed country. It becomes urgent to establish mechanisms that enable the capture of the correct portion of income generated in countries receiving foreign direct investment. This requires the adoption of transfer pricing regulations, automatic information exchange, weak capital formation regulations, etc., that are impossible to apply in a practical manner without effective cooperation between tax administrations. In this regard, the effective cooperation between Mexico and the United States on these matters has resulted in an important mutual professional development for their auditors.

In contrast, the small nations whose domestic markets are not as attractive have developed mechanisms (banking and tax confidentiality) that allow the capturing and recycling of foreign savings in a manner that favours avoidance and evasion in countries of origin. This is relevant because many of these systems preferential to foreign financial savings emerged from tax or financial systems that restrict the financial flows of other jurisdictions, including those of the OECD itself. Negotiation of the definitions themselves and courses of action in this matter must consider mechanisms and agendas that, being created within the framework of trade integration negotiations, generate cooperation mechanisms that make them more equitable and legitimate, especially in countries exporting capital.

In conclusion, in parallel with trade and investment flows, trade agreements create financial movements that have tax implications when there is legislation with non-cooperative liberal tax systems with regard to exchanging information. Failure to consider these elements will be a source of disputes that will affect the legitimacy and efficiency of the agreements.

4. The need to coordinate between trade and tax negotiations (the Anti-Double Dividend).

A paradoxical fact observed especially in the region’s developing countries is the reduction in taxation of the agriculture and livestock sector, especially direct taxation. To the extent that the processes of trade liberalization standardize and reduce levels of tariff protection, effective protection becomes more uniform. With trade liberalization and the consequent reduction of effective protection, it seems reasonable to expect that it is the agriculture and livestock sector and its by-products that, through higher taxation, contribute resources that the State loses. This is especially so for this sector’s exports, which have comparative advantages and cease to have effective negative protection (owing to the decrease in protection of consumables and capital goods). However, as was stated above, a paradoxical drop in direct taxation is being observed in this sector.

The answer to this paradox is in the sector’s limited profitability, a product of the trade protectionism practiced fundamentally by the developed countries, which affects the terms of trade of the region’s countries and makes access to their markets difficult or impossible or even subsidizes their exports. Unlike the “double dividend” created by environmental taxation that at the same time helped to correct negative externalities (due to their lower consumption and therefore lesser damage) to those that added to the collection of established taxes, in this case it would be in the presence of what could be called an “anti-double dividend” tax. On the one hand, protectionist countries must bear the cost to their treasuries of the subsidies they grant and, on the other hand, there are decreasing revenues countries producing agricultural products and their by-products.

Consequently, the exclusion of certain sectors from regional trade negotiations cannot be justified without similar compensation for its tax implications. This is valid for regional negotiations as well as global ones such as the WTO. It is difficult to consider in terms of economic efficiency that the exclusion of sectors from trade liberalization, which gives rise to a second-best allocation of resources and therefore in the efficiency of investments and the wellbeing of consumption on the global or regional scale, cannot be improved by the fiscal transfer of resources.  By the same token, tax compensation is a traditional concept of second-best widely accepted in economic literature. With this compensation, the effect created by excluding certain sectors from free trade is mitigated in terms of inefficiency and unfairness in international trade and public funds, increasing pressure to eliminate them. In the long term these trade limitations must inexorably disappear in order to attain all the benefits of specialization (economies of scale and agglomeration) produced by free trade.

In conclusion, it is not efficient or fair to avoid the tax implications of excluding sectors from trade liberalization. They may be mitigated through compensations that increase the economic efficiency and fairness of the agreements and, consequently, the legitimacy of the same.

5. The need to harmonize indirect taxation and the urgency of coordinated customs procedures.

Just as the experiences of the European Union, MERCOSUR and NAFTA are marked by the harmonization of indirect taxation based on the principles of non-discrimination of external production, they may ensure that intra-branch trade exists at the regional level. However, this coordination must reach an agreement on the bases of the VAT and an agreement on rates on the selective taxes, especially in border countries. There are sales taxes and a series of cascade effects of tax upon tax that affect the competitiveness of countries as they oblige domestic production to compete at a disadvantage. Even with the VAT, when items from the basic basket of goods and services are exempted, for example, these goods incorporate into their cost the VAT paid on consumables and compete with similar imported goods that enter VAT-free. This is because the tax is returned to the countries of origin as they are exports for which the VAT is not applicable. Something similar occurs with the reduction of the VAT rate from 15% to 10% in Mexican states bordering the United States (it also includes the reduction of the selective tax on fuels at the border) to compete for area consumption.

With regard to selective taxes, the difference in rates can encourage smuggling, especially at the border. This has led the EU to not only standardize bases but also establish rate levels.

6. The need for a suitable institutional framework that resolves tax disputes while ensuring the rights of those engaged in international activities.

There exist other factors that may strongly influence the interest of all parties in international businesses, and which make a common effort, as well as leadership, necessary to implement tax coordination in the region, such as administrative capacity and the guarantee of the rights of the other countries that present less tangible elements for assessment. Without legal certainty it is difficult for trade and international investments to thrive. It is therefore necessary to create a framework that is the product of multilateral agreements that ensure the rights of all economic actors, businesspeople, investors, tax authorities and consumers of the different tax jurisdictions. 

Clearly, there are historic factors that determine the weight of law in different countries and at times mark them from the time of their independence. For example, while the United States celebrated the Boston Tea Party under the principle of no taxation without representation in an attempt to establish control over the ruling power, Latin America gained independence under the fate of administrative chaos created by the Napoleonic period that resulted in a feudal  conception in which the rights of the absolute sovereign were granted and created an almost legitimate rejection of state activity, especially the levying that all taxation implies. This process occurred in a region plagued by periods of totalitarian governments where human rights were systematically violated. Taxes, as part of fiscal policy, are in essence only mechanisms for transferring resources between economic agents and their legitimacy is based on representation, social participation that gives the tax authority the right to collect taxes and is simply a complex social expression of human rights. 

Another historical feature is that, to a large extent, in Anglo-Saxon colonization, rights have been guaranteed in the constitution and rule of law through an influential judicial branch since the famous rulings of John Marshall at the dawn of the 19^th Century.

However, in recent decades, although many aspects of public administration must be improved, the region has with effort advanced significantly, strengthening democracy and the constitutional state in recent years. The region has made important sacrifices to impose fiscal discipline within the framework of legal validity and respect for civil rights.

The recognition of an agreed institutional framework that has jurisdictional effects, although not expressed supranationally, will have a positive institutional effect that, especially in developing countries, will reduce uncertainty in trade and investments as well as foreign savings instruments and partially reduce the cost of capital tied to country risk.   

Finally, although sharing tariff collection to sustain common expenditures as in the EU is not expected in the hemispheric integration agreements, close to 40% of revenue in the region is collected from customs. This is in addition to the definition of rules of origin that requires a regional value-added percentage to be considered an intra-regional good, for which customs must operate at a level that they do not have today. Moreover, this will favour exchanges, reducing the costs of trade while constituting one of the main bases of information for internal tax inspection.

5.  
   Conclusion

Trade and financial liberalization, as well as regional economic integration processes, present new opportunities and also new challenges for the countries of Latin America and the Caribbean.

With the regional free trade agreements, which practically eliminate import tariffs, lost income must be recovered (see yesterday’s issue of Mercurio). More resources must be generated to compensate those who lose at free trade (for example, training programs for displaced workers) and there must be an attempt to coordinate taxation policies between countries so that they do not unfairly compete with each other, but rather coexist harmoniously. 

Yet this coordination is not easy to achieve at the regional level. We believe it can begin with:

• Strengthening taxation agreements;
• Achieving a minimum harmonization of indirect taxation, such as the VAT and selective taxes;
• Consensus on transfer prices for equitable distribution of income from international activities;
• Eliminating harmful taxation practices regarding capture of savings and avoiding tax wars for investment, especially foreign direct investment;
• Above all, increasing cooperation between the tax authorities of the region’s countries with common procedures and exchange of information. 

Owing to this, as was the experience of the European Union and NAFTA (see Annexes 1 and 2), taxation matters must be dealt with in parallel with trade and investment issues.

Meanwhile, with regard to each country’s internal political economy, this conjuncture of trade liberalization presents an opportunity to obtain consensus and political support for the required tax reforms, as each country must face a new economic reality and attempt to maximize its competitiveness.

6.  
   ANNEX 1 – The Development of Tax Coordination in the European Union⁴

The European integration process has its origins in 1951 with the European Coal and Steel Community (ECSC)⁵, which brought together six countries with the objective of creating a common market for iron and steel products by eliminating tariffs, quotas, subsidies and other forms of trade restrictions. In 1957, the Treaty of Rome established the European Economic Community (EEC), a customs union (internal free trade and common external tariffs were achieved by 1968), where the free circulation of persons, services and capital was proposed in addition to the free circulation of goods. This integration process saw more than 30 years of advances and setbacks until the Single European Act (SEA) of 1985 effectively launched the conditions for a genuine integrated market of goods, services, capital and employment, creating strong supranational institutions and redistributive structural funds to diminish disparities between countries, as well as new voting and veto regulations.

The creation of the single market resulted in an extensive process of harmonization, standardization, regulation and certification of goods, services and procedures, the elimination of many trade barriers and the end of customs formalities at national borders, which were replaced by Community instruments. As the objective of eliminating capital controls within the Community was established, the need to establish a monetary union was recognized.

Arguing that a genuine integrated market for goods, services and capital requires a single currency to reduce transaction costs, make prices more transparent, reduce the influence of the dollar and encourage the unification of financial markets, the Maastricht Treaty of 1991 rebaptized the EEC as the European Union (EU) and launched the conditions for the European Monetary Union (EMU) that began on 1 January 1999 with the participation of eleven countries.

1. First phase (1967-1993): The role of tax harmonization during the beginning of the Single Market

1. Value-Added Tax

In order to strengthen the customs union and eliminate tax barriers to the free flow of goods and services, in addition to the elimination of tariffs, it was necessary to establish a neutral tax on trade between member countries.

The First Community Directive⁶ of 1967 stipulated that all countries must adopt a VAT-type general sales tax before January 1970. The Second Directive, also of 1967, guaranteed a strong degree of harmonization by establishing the structure, methods and technical principles of the new tax, which would follow the jurisdictional principle of destination, with corresponding border adjustments in the case of international trade. This would permit eliminating tax on exports and taxing imports, thus avoiding cascading and enabling a precise border adjustment.

Subsequent Community directives, particularly the Sixth Directive of May 1977 that came into force in 1979, attempted to specify the structure of the VAT that would be in force in the Community, though always leaving some freedom for countries to establish limited special agreements and exemptions and initially leaving extensive freedom to fix rate levels. The purpose of the directives was always to define tax bases in order to avoid the risk of cascading as much as possible and to perfect the principle of non-discrimination between imported and domestic goods. This preoccupation, to a great extent, has arisen from the fact that since its beginning in the 1970s, 1% of the VAT⁷ tax base was allocated to finance the Community’s budget and therefore it was necessary to uniformly and precisely determine the tax base on which the contribution of each member country was calculated.

Starting from the European Community Commission report on “Perspectives of Convergence of Community Fiscal Systems” of 1 March 1980, it is believed that in order to strengthen the domestic market and guarantee the competitiveness of member country companies, Community action should be focussed on harmonizing the VAT, as well as excise taxes and corporate income tax. 

From the perspective of the beginning of the borderless domestic market on 1 January 1993, which implied the elimination of customs and transformation of the Community market into a large domestic market, it became necessary to achieve a high degree of harmonization of indirect taxes to avoid barriers to the free movement of goods and supply of services within the Community market. To do this, convergence of VAT rates was considered a top priority, smoothing the way for the transformation of the jurisdictional principle of destination to that of origin and thus making it possible to eliminate border controls that were necessary to make tax credit adjustments. As is known, the modification of the jurisdictional principle requires as a sine qua non the equalization of VAT rates among member countries in order to avoid tax shopping.

The problems emerging from the rigid requirement of rate equalization turned the decision in favour of continuing with the destination principle for the VAT, applicable from the start, although the elimination of border controls was a challenge. In this sense a first proposal was drafted, consisting of a Community clearing house mechanism among member states that would operate as a central compensation account where net exporting countries would charge the same through adjustments of monthly accounts. That proposal also established a significant convergence of VAT rates with a general rate between 14 and 20% and a reduced rate between 4 and 9%. Because most countries did not accept the convergence of rates and considered application of the clearing house system very difficult, the proposal was rejected.

In view of this, at the end of 1991 a transitional VAT arrangement was established, following the destination principle but without border adjustment. It should have been in effect from 1993 to 1996, but continues to be applicable today. 

Administratively, since 1 January 1993 ushered in the new VAT system for the single market, the terms of import and export were abolished between member states and became known as “intra-Community deliveries”. The provision of goods between member states must not include the VAT in sales within the member state of origin, on the condition that the purchaser in the country of destination appears in the VAT registry and the goods leave national territory. Intra-Community purchases of goods (former imports between member countries) are taxable in the member state where consumption takes place and must be declared by the purchaser in his VAT declaration. This entails a time spread system for the VAT in intra-Community operations, in which the transfer of preliminary control that was supported by border controls is audited in the books of taxpayers involved in the operation.

A computerized system for the exchange of information between national administrations⁸ has been created for this purpose and contains information included in intra-Community deliveries of goods. VAT is always applied in the country of consumption, with three exceptions: a) long distance sales to individuals⁹, b) intra-Community purchases of vehicles¹⁰ and c) farmers’ purchases when buying from persons exempt from the tax.

However, the Commission acknowledges that applying the VAT at origin would be a better system with fewer compliance and administration costs and less susceptible to fraud. In other words, a true domestic market would be achieved if intra-Community sales of goods and services were treated in the same manner as those within member states, although this has not been achieved to date. In addition, it is acknowledged that the risk of irregularities detected in the control of the system has increased. There are two principal methods of fraud: a) declaring false intra-Community deliveries, as exempt goods are actually sold on the domestic market without paying tax, and b) not declaring the VAT returned in intra-Community purchases, which are then sold on the underground market.

It should be emphasized that for more than three decades, tax revenues from the common customs tariff that taxes imports from outside the Community are collected by the country of entry of goods and is allocated to financing the Community budget.

2. Excise Consumption Taxes

With regard to other taxes on goods, the main advance consisted of defining and harmonizing terms and conditions for charging excise taxes on the consumption of alcoholic beverages, cigarettes and other tobacco products, and petroleum and natural gas products. In addition, Community Directive 82 of 19 October 1992 established minimum amounts of tax for these three categories.

Despite having fixed a minimum amount of tax, thereby harmonizing the base, the effective rate charged continues to be very different among countries. For example, in July 2001 gasoline, with a minimum of 0.337 euros per litre, was taxed at a simple average of 0.484 euros with a standard deviation of 0.131, while diesel had a fixed minimum of 0.245, an average charge of 0.35 and a deviation of 0.138.

In the case of alcoholic beverages, wine, for example, does not have a minimum tax amount and the Community average tax reached 0.87 euros per litre with a rate deviation of 1.16 given that half of the member countries do not tax it. Only on cigarettes where a mixed excise tax system was established, with one part excise and the other ad valorem, was a convergence of tax charges reached with an average of 60% of the consumer price and a minimum of 57%.

Furthermore, to make the end of internal customs barriers feasible, Community Directive 92/12 established a system of suspension for intra-Community sales of goods subject to excise between registered taxpayers, including administrative safeguards for its control that verify the application of the destination principle.

3. Direct Taxation

In this first phase successes have been meagre in terms of harmonization of direct taxes, especially in the case of income tax. Member countries did not want to abdicate their tax sovereignty on this issue and believed that what was important for consolidating trade integration between them involved indirect taxation on goods and services. For example, the Commission submitted proposed directives in 1975, 1984 and 1985 that focussed on compensating losses originating in a member state to be deducted from the income tax of another jurisdiction. These were withdrawn given the reluctance of member countries to adopt them.   

A project in 1988 to harmonize the corporate income tax base was never presented due to the reluctance of most member states. However, in 1990 two Community Directives were adopted, 434 on Mergers and 435 on Parent Companies and Subsidiaries. Both directives are currently on the agenda for review by the Commission.

Finally, two types of measures were adopted concerning direct taxation, which could also affect indirect taxation. One was the Arbitration Convention 90/436 which attempted to facilitate a dispute resolution procedure binding those arising from cross-border transactions, a procedure that is almost never used. The Commission has indicated that it will submit a proposal to improve it and allow its provisions to be subject to interpretation by the Community Court of Justice.

The second type refers to the method of administrative determination of international transactions between companies linked in terms of transfer prices. Given that all countries of the European Union are also members of the OECD, they have adopted the principles stipulated in the Directives regarding transfer prices that the OECD has been establishing since 1979 and put into effect in a Transfer Prices Manual published in 1995. However, as each country dictates its own rules, in practice compliance costs and a series of taxation problems between related parties are generated and carry a risk of double taxation.

4. 1.1.4 European Union institutions affecting taxation

The European Union has a unique institutional system in the sense that member states agreed to delegate part of their sovereignty to independent institutions that represent Community interests.

The legislative function is shared by the Council of the European Union, the Community’s main decision-making body and consisting of ministries of different areas of interest, and the European Parliament, elected every five years by direct universal suffrage. These two bodies approve European laws in the form of Directives, Regulations or Decisions. 

The European Court of Justice is the supranational judicial branch and its mission is to ensure compliance with law and to apply and interpret constitutive treaties and provisions adopted by competent institutions. Within the various categories of legal recourses, the most important for taxation issues are the recourses for non-compliance and cancellation. The former allows the Court to control how the member states meet their obligations under Community law, enabling it to force them to comply and sanction them with fines if they do not. The latter allows member states, the Council or the Commission to request total or partial cancellation of Community provisions and allows individuals to request cancellation of legal transactions directly affecting them.

The Court of Justice is responsible for ensuring the interpretation and application of Community law while the courts of each member state resolve conflicts resulting from national tax legislation. These are also Community jurisdictional bodies in the sense that they are under its control in the administrative application of Community law and the Court of Justice’s ruling on each dispute in question. Furthermore, interpretations of Community law established in its rulings serve to guide national jurisdictional bodies. Once a dispute is referred to the Court of Justice, its rulings are final. The Court’s rulings are adopted by majority vote in a public hearing.

2. Second Phase (1994-2001): Advances in tax coordination to make Monetary Union viable

Since the single domestic market came into effect in 1993, the focus of attention on the elimination of tax barriers to the free circulation of goods and services was relegated to second place. The Community’s main objective on the issue of taxation is currently to make tax structures compatible. The development of a single market with a single currency eliminates exchange risks and reduces transaction costs, but also makes differences between national tax systems that affect decisions on allocation of factors more evident, especially with capital. Consequently, the need to make tax systems compatible and deal with problems caused by differential tax treatment among members becomes imperative to ensure the good performance of the single market and establishment of the monetary union.

In effect, as the Commission¹¹ itself recognizes, European tax coordination has been curbed by two big obstacles. The first is the institutional framework for decision-making. The unanimity requirement applied in the Council of Europe to taxation decisions makes it very difficult to negotiate them.

The second obstacle is the lack of a global perspective that would enable economic and social drawbacks caused by the lack of Community decisions to be overcome. The repeated failures in tax coordination have contributed to maintaining distortions in the single market such as unemployment and the erosion of the tax base. The apparent defence of national tax sovereignty has gradually led to a genuine loss of the same for each member state in market benefits, especially those where there is greater factor mobility. To counteract this phenomenon, member countries have been obliged to excessively tax the employment factor, increasing unemployment and worsening the distribution of income.

To this effect, the Economic and Financial Council (ECOFIN) meeting in Verona in 1996 established the need for progress in tax coordination within the Community with a new, more comprehensive vision of taxation policy to confront three interrelated challenges:

1. Stabilizing the tax revenues of member countries,
2. Promoting employment, and
3. Ensuring the efficient performance of the domestic market.

The ability of tax revenue to guarantee a solid taxation policy compatible with the one agreed upon in the Maastricht Treaty becomes a priority in achieving a successful monetary union predicted for the end of the last decade. The Stability and Growth Pact signed at the Council of Amsterdam in June 1997 limited the use of the public deficit as an instrument of political economy and member states committed to submitting annual stability or convergence programs that demonstrate the necessary means to reach the goal of a balanced budget or surplus.

At the same time studies on growth, competitiveness and employment¹² in the Community highlight the need to stop the relative excess of taxes supporting the employment factor in order to promote employment in the EU. In addition to the impact of the heavy taxation of wages on the cost of labour and the level of employment, it furthers tax degradation and is worrisome in the sense that it threatens financing of pension systems when the employment factor can no longer absorb the tax burden. Furthermore, as highly skilled and paid workers are the most mobile, and therefore highly sensitive to differential tax treatment between countries, the tax burden tends to fall more heavily on less skilled and poorly paid workers.

To ensure the single market’s efficient performance, three taxation objectives were established within the framework of the European Union’s general policies:

1. To promote taxation policies that guarantee the four basic freedoms of the domestic market: the free movement of goods, services, capital and persons.
2. To promote initiatives in the taxation field that contribute to the greatest possible efficiency in market performance through reducing nominal rates and expanding tax bases to minimize economic distortions and the transaction and administrative costs of navigating through fifteen different tax systems.
3. To ensure that tax systems incorporate measures to eliminate harmful competition that damages the fiscal independence of member states so that investment decisions are made based on the intrinsic quality of the country’s advantages and not on the possibilities of tax evasion.

To meet these objectives, in December 1997 ECOFIN established a package of measures to confront harmful or destructive tax competition which comprised:

1. A Code of Conduct in the field of corporate taxation by which the member states committed politically to abstaining from adopting any harmful tax competition measure, although it is not a legally binding document per se,
2. Measures aimed at eliminating distortions in capital income tax and, in particular, eliminating withholding at source of interest payments and taxes between companies of the same group within the borders of the EU, given that it may create excessive compliance costs and double taxation.

The Code of Conduct defines a collection of measures aimed at avoiding the application of regulations that would result in a very low or zero tax rate and might significantly affect the allocation of corporate activity within the Community. In this way, the Code provides criteria for defining destructive taxation measures. To follow this, the countries committed to:

1. Not introducing new harmful competition measures;
2. Reviewing their current legislation and practices and eliminating harmful taxation instruments within a certain timeframe;
3. Establishing a group to evaluate which measures fall within harmful competition and verify the effective application of points i and ii;
4. Promoting the adoption of principles aimed at abolishing destructive tax measures in territories and countries outside the Community.

While the countries typically extend the jurisdictional principle to capture income earned by their residents abroad, the fact that capital flows are increasingly volatile generally implies that income from interest paid by banks are subject to low taxes at source, whereby international recipients of this income can avoid paying income tax relatively easily. In order to combat this situation, in 1989 there was a preliminary frustrated attempt in the EU to establish minimum withholding at source in all member countries as a way to guarantee homogenous taxation of this kind of income and protect tax bases.

In 1998 another proposed community directive attempted to coordinate national systems of taxing savings to guarantee that interest earned by non-residents of a member state is actually taxed at a minimum level, thus eliminating possibilities for evasion and the economic distortions  they may cause and which are incompatible with the existence of a single domestic market.  The idea was that member states could opt for a system of supplying information to the member state of tax residence of the individual receiving the interest payment in order to control the correct assessment of income tax, or for a system of withholding at source of a minimum of 20% on interest paid by the paying agent to cash recipients. 

In spite of this, in November 2000 there was a political agreement, which has still not been implemented as a community directive, stating that from 2010 the information exchange system will be the mechanism adopted to guarantee the proper taxation of interest received in the receivers’ countries of residence. Until then, starting in 2003, Austria, Belgium and Luxembourg will be able to withhold at source a minimum of 15% until 2005 and 20% from 2006 to 2009. Of the taxes collected, 75% will be transferred to the tax authority of the receiver’s country of residence.

The other countries will adopt a system of providing information to the authorities of receivers’ countries of residence to be included in the income tax base starting in 2003.

Another problem identified and for which there is a proposed directive not yet approved is the treatment of interest and tax payments made between related parties of different member states.

3. Other aspects of taxation agreed upon by the European Union

1. E-commerce and telecommunications

In the case of sales of tangibles through e-commerce, treatment is the same as normal trade in goods under the destination principle in purchases by both companies and final consumers. Intra-community deliveries are exempt and taxed in the receiving country. Therefore, if they are sold to final consumers, the vendor¹³ must register in the country of destination and pay the VAT, as occurs with long distance sales. For transactions with third countries, the same destination principle is applied. If a Community consumer buys tangible goods abroad worth more than 30 euros electronically, he will pay the tax at the customs entry point of the shipment. If a Community company sells goods to third countries electronically, it is taxed at a zero rate.

In the case of intangibles, the Community follows the guidelines of the OECD Conference on E-Commerce of 1998 and therefore digitized products are considered services and not goods. If a Community company sells to a final consumer, it must pay the VAT in the country of origin, and the same should occur if the vendor is an extra-Community company¹⁴. This attempts to prevent unfair competition.

In the case of telecommunications, an extra-Community provider must register in the country of consumption and pay the corresponding VAT in order to sell its services. When the provider is from within the Community, it must also register and pay the tax in the consumer’s country in order to operate. When a Community company provides service to third countries, it is considered an export and therefore is entitled to a tax credit for its consumables.

2. Financing

Since the creation of the European Coal and Steel Community in 1951, sources of Community financing were established, which in this case were levies based on coal and steel production. The same thing occurred with the European Economic Community and later the European Union. Initially, national contributions were determined by a percentage of the budgetary expenditure of member states until they were replaced in 1970 by resources from agricultural levies, contributions on sugar production, customs duties collected at the Community’s external borders and 1% of the VAT tax base collected by each member. 

In 1985 the Community’s budgetary needs caused the VAT contribution to be raised from 1% to 1.4%, which led to the creation in 1988 of a supplementary system based on the GNP of member countries. With the new system, the VAT contribution returned to 1% in 1999, and the additional financing to balance the Community budget comes from the contribution based on GNP, which cannot exceed 1.27% of a country’s GNP. It should be noted that the VAT contribution and the supplementary GNP contribution finance more than 80% of Community expenditure.

7. ANNEX 2 – Double Taxation Agreement between Mexico and the USA: The case of maquiladoras

On 18 September 1992 the governments of Mexico and the United States signed an agreement to avoid double taxation with the objective of eliminating tax barriers to trade and investment flows between the two countries. Since it came into effect, this instrument has proved to be an efficient mechanism for: i) giving certainty to tax treatment applicable to investors from both countries, ii) resolving tax disputes between jurisdictions and iii) preventing tax evasion through the exchange of information between the tax authorities of both countries.

One of the most important aspects of this bilateral agreement has been the level of cooperation achieved between the countries to distribute tax bases and establish tax jurisdictions. The mutual agreement reached between Mexican and American authorities, through the Ministry of Finance and Public Credit and the Treasury Department, on the tax system applicable to maquiladoras is one of the clearest examples of the benefits produced by agreements to avoid double taxation.   

Under this system, maquiladoras or cost centres established in Mexico and owned by US residents will not pay taxes in that country as a permanent establishment and will comply with its transfer prices regulation, provided that they declare a minimum fiscal profit based on a pre-established factor (safe harbour). In this way, the profit generated for Mexican income tax purposes must be less than 6.9% of the value of its assets or 6.5% of the total amount of its operation costs, whichever is greater.

Alternatively, maquiladoras can opt for obtaining an advance price agreement from the Mexican Servicio de Administración Tributaria (SAT) [Tax Administration Service], through which it is confirmed that they have complied with the transfer prices regulations established in Mexican legislation. This solution may result from an agreement with the competent US authority, in this case the Internal Revenue Service (IRS).

The mutual agreement on the tax system applicable to the maquiladora industry in Mexico would be in effect until the OECD defines the regulations applicable internationally regarding allocation of income generated by multinational manufacturing companies. Meanwhile, the system gives legal security to both current and potential investors by establishing specific procedures for complying with the current legislation in each country.

In parallel with the bilateral agreements signed by the US government, Mexico has taken some unilateral tax concession measures in border areas, specifically in its indirect taxation structure and public sector prices. The objective is to seek tax neutrality schemes for operations performed in the border area while protecting the competitiveness of companies established in Mexico. As in the example above, it should be noted that: 

1. The VAT rate applicable was reduced in this region (from 15 to 10%) to make it comparable to sales tax in US border states, and
2. The price of gasoline was equalized by reducing the specific tax and price administered to compete with the supply in the USA. 

Although these measures have resulted in a tax concession for the Mexican government, it has also permitted avoidance of distortions in the extensive and dynamic trade exchange taking place at the border of both countries. 

* * * * *