Mexico’s 16% Discount for Paying Cash Shows Tax Evasion’s Allure

On a warm afternoon last month, Mexican central bank Governor Agustin Carstens looked out over sun-drenched piles of dirt and construction equipment near Guadalajara and hailed the groundbreaking of a new currency-printing plant as a sign of a solid economy.
There’s one catalyst for rising cash demand that isn’t a cause for celebration: tax evasion.

Mexicans increasingly are leaving their credit cards in their wallets and using cash instead to pay for everything from electronics to doctor’s visits and even the plumber. This allows retailers and service providers to skip collecting a 16 percent value-added tax and pass the savings on to the customer. In exchange, the businesses avoid creating a paper trail, allowing them to under-report their earnings to authorities and lower their income-tax bill.

The scheme may be a win-win for shoppers and the shops, but it’s a blow for government coffers just as the nation needs the revenue more than ever. Oil income as a percentage of total government receipts has tumbled by almost half. That’s partly because of the plunge in prices — Mexico’s crude mix is down about 64 percent since its 2014 peak — but it’s also largely by design.

After taking office in 2012, President Enrique Pena Nieto engineered a tax overhaul to reduce the government’s dependence on the energy industry, ushering in a wave of higher tariffs on consumers and businesses that took effect at the beginning of last year. While the new system is boosting revenue, it also may be causing the spread of cash transactions.

“Whenever taxes increase, there’s an increase in the incentive for people to evade them,” said Carlos Capistran, the chief Mexico economist at Bank of America Corp. in Mexico City. “One way to do that is to use more cash.”

Pesos in circulation jumped 17 percent in 2014 after levies were raised, the most since 1999, eclipsing the 2.5 percent increase in credit-card debt, according to the central bank and the nation’s banking and securities commission. Growth has slowed since then, but it still tops credit-card gains. Before the overhaul, card debt was growing at a faster pace.

Mexico’s peso gained 0.1 percent Monday to 16.7875 per dollar as of 3:56 p.m. in New York.

Mexico has a history of tax dodgers, even though its tax burden — 20 percent of gross domestic product — ranked last among the 34 countries in the Organization for Economic Cooperation and Development in 2012, according to an OECD study. Evasion from 1999 to 2010 amounted to an average 6.8 percent of GDP, the highest in the OECD, according to a 2012 paper co-written by Friedrich Schneider, an economics professor at Johannes Kepler University in Linz, Austria.

“It’s weakness of the tax system,” Schneider said from Zurich. “Cash is not visible to tax authorities. If people used credit cards more, there would be less tax evasion.”

So prominent is the trend that the central bank dedicated four pages of its 75-page quarterly inflation report in May to highlighting the rising preference for cash and its potential connections to tax evasion. The top evaders, the central bank said, may be in cities closest to the U.S. border, where resistance to the overhaul was widespread, sparking protests in which pinatas made to look like Finance Minister Luis Videgaray were burned. Growth in the use of cash last year at shopping centers in northern cities including Nogales, Tijuana and Hermosillo exceeded expectations, according to the report.

The central bank said in response to e-mailed questions that it expects the faster growth in demand for cash due to the tax changes to dissipate over time. The Finance Ministry declined to comment.

While Mexico’s tax overhaul may have led to increased efforts at evasion, it also has succeeded in bolstering non-oil receipts. The adjustments included a higher income-tax rate for the nation’s top-earning individuals, new duties on sugary drinks and fatty foods, and closing some corporate loopholes.

At the stalls of one of the biggest electronics bazaars in Mexico City’s historic downtown, vendors openly discuss two sets of prices: one for purchases in cash and another for those with a credit card and a receipt. Offering to pay in cash, for example, earns a $65 discount off a $400 iPad 4 or about $150 off a $900 55-inch Sony flat-screen TV.

“The consumer has a huge incentive for not wanting an invoice,” Jonathan Heath, an independent economist who previously served as chief Latin American economist with HSBC Holdings Plc, said from Mexico City. “It means the price could be 16 percent cheaper. On the provider side, you don’t have to register the income as taxable.”