Classification of taxes in Mexico: Types and functions

In any country’s economic system, taxes play a fundamental role in ensuring the proper functioning of the state. Mexico is no exception, and its tax structure is organized based on various types and functions that enable the financing of public services, reduction of inequalities, and promotion of development.

Taxes are mandatory contributions, whether in cash or kind, made to support the strengthening of the national economy. These payments aim to provide the government with the necessary resources to achieve its planned objectives. Tax revenue is allocated to meet collective needs such as public education, justice, security, healthcare, sports, road infrastructure, and services and programs and projects for social and economic development. Thanks to tax contributions, it is possible to finance essential services that benefit society. Below, we present the classification of taxes in Mexico and more information about them.

 

Types of taxes in Mexico

Taxes in Mexico are divided into three categories based on taxpayers’ different tax regimes. The Tax Administration Service (SAT) is the institution responsible for supervising and ensuring compliance with tax obligations, enforcing tax regulations, and ensuring that both individuals and legal entities pay taxes to support the financing of public expenditures in the country.

This classification of taxes is governed by public law, making it mandatory for all Mexicans:

• Federal taxes: These are fundamental contributions that apply nationwide and must be fulfilled by the majority of Mexican taxpayers and foreign residents conducting economic activities within Mexico. Examples include the Income Tax (ISR), Value-Added Tax (IVA), and Special Tax on Production and Services (IEPS), among others.
• State taxes: These contributions correspond to each state and cannot be applied across entities. Each state has its own tax regulations or Treasury Law, which details residents’ taxes. Examples include vehicle ownership tax, water fees, civil registry taxes, lotteries, and raffles.
• Municipal taxes: These contributions are established by local governments and apply to the residents within their jurisdiction. They are legal tools that empower municipalities to collect revenue from those with rights within their territory. Examples include taxes on public events and property taxes (predial), among others.

Direct Taxes

According to the classification of taxes in Mexico, there is a distinction between different types of contributions. Direct taxes are characterized by being levied explicitly on income, wealth, or the assets of individuals and businesses. They are applied directly to taxpayers and reflect their economic capacity. Some examples of direct taxes in Mexico include:

1. Income Tax (ISR): This tax is levied on the income earned by individuals and legal entities. Its goal is to ensure that higher-income people contribute more proportionally to the public treasury. The rates vary depending on income levels, promoting progressivity within the tax system.
2. Property Tax (Predial): This tax falls under municipal taxes and is levied on real estate properties, considering factors such as the property’s cadastral value. Its collection helps fund local services like public lighting, security, and infrastructure maintenance.

Indirect taxes

Indirect taxes are not levied directly on income or wealth but on consuming goods and services. These taxes are considered regressive, as all consumers pay them equally, regardless of income level. Some of the most common indirect taxes in Mexico include:

1. Value-added tax (IVA): This tax applies to the consumption of most goods and services. In Mexico, the general rate is 16%, although reduced rates of 0% are applied to basic products like food and medicine.
2. Special Tax on Production and Services (IEPS): This tax is imposed on specific products such as gasoline, alcohol, tobacco, and sugary drinks. Its aim is to discourage the consumption of goods that may negatively impact health or the environment.
3. Import Taxes: This levy is applied to goods imported into the country, encouraging the consumption of domestic products and protecting local industries.

Functions of taxes

Taxes generate revenue and fulfill economic and social functions. These functions ensure a balance between economic development and social well-being.

Public resource collection

The primary function of taxes is to generate income for the state. These resources are allocated to finance essential services such as:

• Education: Construction of schools, payment for teachers, and access to education programs.
• Health: Maintenance of hospitals, purchase of medicines, and free or subsidized medical care.
• Security: Support for security forces, equipment, and crime prevention programs.
• Infrastructure: Construction and maintenance of roads, bridges, water supply systems, etc.

Redistribution of wealth

Another key function of taxes is the redistribution of wealth. A progressive tax system, such as the Income Tax (ISR), aims for individuals with higher incomes to contribute more to public spending. These resources are allocated to social programs that benefit vulnerable populations, promoting more significant social equity.

Examples of redistribution include:

• Subsidies for essential food items.
• Social housing programs.
• Direct monetary transfers to marginalized sectors.

Impact of taxes on the economy

Taxes significantly impact a country’s economy, influencing both economic growth and the behavior of consumers and businesses. The tax system can either stimulate or hinder economic growth, depending on how it is structured:

• Stimulating investment: A well-designed tax system can encourage business investment through tax incentives, such as expense deductions or reduced tax rates for strategic sectors.
• Disincentives to consumption or production: High taxes, particularly indirect taxes like VAT or IEPS, can reduce consumers’ purchasing power. This may limit the growth of specific sectors, although it also helps regulate behaviors that affect health or the environment.
• Promoting competitiveness: Implementing moderate taxes on businesses can attract foreign investments, create jobs, and strengthen the economy.

Challenges and opportunities of the Mexican tax system

Although the Mexican tax system is a key tool for economic development, it also faces significant challenges:

1. Tax evasion: A considerable portion of taxpayers evade paying taxes, which limits the state’s ability to finance essential programs. Digitalization and advanced technologies can be tools to combat this issue.
2. Expanding the tax base: Mexico needs to find mechanisms to include more taxpayers in the fiscal system, particularly in the informal sector, representing a large part of the economy.
3. Tax reforms: Reforms are needed to balance the tax burden between businesses and citizens, while also promoting the progressivity of the system.

 

The classification of taxes in Mexico, divided into direct and indirect taxes, reflects their multifaceted role in the economy. From raising funds for essential services to promoting social equity and stimulating economic growth, taxes are a powerful tool for the nation’s development.

However, their effectiveness depends on a fair and efficient tax design and measures to combat evasion and modernize the tax system to achieve inclusive and sustainable growth. Visit our specialized sections to learn more about how taxes impact the Mexican industry and economy.