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Mexico’s position addressing climate change: A tax policy analysis

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Mexico needs to make changes to tax policy and environmental provisions in light of COP26

Federico Scheffler and Ana Elena Domínguez of Galicia Abogados evaluate Mexico’s commitments to improve its environmental performances via tax policy in light of developments at COP26.

Following the 26th Conference of the Parties (COP26) of the United Nations Framework Convention on Climate Change, Mexico has recognised and expressed its willingness to implement additional policies in order to meet the 2030 target of reducing greenhouse gas emissions (GHG) and to reach net zero emissions by 2050. 

For its expected action plan – which will need to be submitted by each country in 2022 at COP27 – Mexico will need to include a series of essential changes to its tax policy and environmental provisions if it wants to comply with its promises that has made at COP26. 

As of 2021, Mexico remains as one of the world’s largest GHG emitters. However, especially since 2013 with the past administrations, the country had actively tried to bear the effects of climate change by introducing important measures, regulations and amendments with the intention of cutting emissions and developing clean power. This includes steps such as granting renewable energy certificates to producers of electric power from renewable sources and through imposing a carbon tax. However, when looking at its efforts on a global scale, Mexico’s climate progress has been comparatively slow and its emissions have continued to rise. 

Environmental measures: Wheel of fortune

From previous years to date, Mexico has had a series of ups and downs in connection with environmental matters and its commitment to partake in the race to net zero. In 2013, Mexico introduced a comprehensive energy reform intended to generate 35% of Mexico’s electricity from clean sources by 2024 – and one interim target was reaching 30% by 2021. However by 2020, just 25% of electricity came from clean sources and no further increase is foreseen by the end of 2021. 

Despite Mexico’s commitment towards tackling climate change, fighting environmental issues and introducing mitigation measures, the current administration’s decisions have put the global compromises adopted by Mexico in connection with climate change in question – including those adopted in the Paris Agreement during 2015. 

The Mexican new administration has backtracked on many of the 2013 reforms and it seems that the recent regulations and proposed amendments to several legal provisions, all tending to support fossil fuel, coal and oil sectors in the country, effectively triggers a deviation from international goals to limit global warming. 

The most important amendment proposed by the current administration is a controversial constitutional reform, which aims to reassert the Mexican government’s control over the electric power sector. This control was taken away through a constitutional amendment in 2013 that ended a 75-year state monopoly in the oil and gas industry, and in turn, it opened the electric power sector to the participation of private investors with the intention of developing and regulating the electric power industry to start generating energy from clean sources. 

The proposed constitutional amendment would reverse certain changes in Mexico’s electric power sector and re-establish the Mexican government’s control over the electric and hydrocarbons industry. The move would thereby grant the Mexican government total control over power generation, transmission, transformation, distribution, marketing and supply. This proposed amendment is of real concern, especially since the current government has shown through the proposal visible signs of preferring to burn fossil fuels. 

As of December 2021, the bill is being discussed in the Mexican Congress and is subject to review. If the amendment is enacted in its current form, it will drastically change the regulatory framework and landscape of the electric power sector in Mexico, with adverse effects on global climate change.

The government’s decisions are on the basis that renewables are no longer sufficient for fulfilling the needs of the population, arguing that Mexico does not have sufficient financial, technical and operational resources to provide efficient, low-cost and reliable electricity, and justifying that new projects supporting fossil fuels are “necessary” to ensure that energy bills would not increase more than inflation for individuals. 

Even where the government would ensure compliance with environmental commitments, the truth is that year after year, the country’s efforts are considered as “highly insufficient”. 

However, as per the recent dialogue at COP26, Mexico’s position should change radically, since considering the new commitments adopted at this conference, our country necessarily has to reconsider new measures for limiting global warming and the way to generate renewables. 

Initiatives from COP26

At COP26, Mexico supported the initiative for curbing methane emissions by signing the Declaration for the Reduction of Methane, which seeks to reduce the polluting emissions of such gas by up to 30% by 2030, in accordance with 2020 emissions.

In addition, Mexico committed to halt and reverse forest loss by signing the Declaration on Forests and Land Use, which aims to preserve and restore forests over the next decade. Mexico also drew up and prepared the Instrumentation Strategy for a Sustainable Ocean Economy 2021-2024. 

Even when Mexico failed to ensure a specific year in which the country will be able to achieve zero GHG emissions and stop burning coal, the international joint objective is to get rid of the internal combustion engine, accelerate the removal of coal and end international financing of fossil fuels in order to combat climate change. 

Derived from the above, the discussion about climate change in COP26, and the duty for countries to return in 2022 and present stronger emission reduction targets for 2030 and reach the gap to limit global warming to 1.5°C, represents a great opportunity for Mexico to review its commitments, position itself as a leading country in environmental matters and take significant steps toward the fulfilment of its global warming compromises. However, early indications leads us to believe that this will be difficult or highly unlikely. 

In order to achieve said goals, the Mexican administration would need to reconsider its position for several sectors – mainly the hydroelectric energy, being the most important one – since 4% of electricity comes from fuel and is responsible for 10% of the GHG emissions in the country. 

In addition, even when the current administration ensures that hydroelectric energy is “the cheapest and cleanest”, experts have stated that it is three times more expensive than solar and wind, and considered less clean because of its resulting methane emissions. 

Independent analysts question the idea that hydroelectric plants can increase their generation enough to reach Mexico’s proposed target of 35% of clean energy by 2030. 

Moreover, hydroelectric plants are controlled by the state-owned Federal Electricity Commission (CFE) and were built between the 1960s and 1980s, so they are quite outdated and operate with fossil fuels such as fuel oil, which is one of the main pollutants.

Also, the use of gas and coal triggers deforestation of large areas of land in Mexico, which releases CO2 into the atmosphere and ecosystems, and as a result, the population’s way of life is affected. 

Before deciding to rehabilitate existing hydroelectric plants, Mexico should make a good assessment of what alternative strategies are available and less pollutant today, such as amending current Mexican tax policy and environmental goals. 

Mexican tax policy 

Global commitments to fight climate change cannot be achieved without putting the entire tax system at the service of climate transition. 

In this sense, every country (including Mexico) needs an ambitious and comprehensive fiscal action plan designed to reduce carbon emissions, aiming to finance decarbonisation in the richer countries and help developing countries do the same. 

At the recent G20 Summit, the biggest economies endorsed a 15% global minimum tax rate and reallocation threshold of 25% of the largest companies’ residual profits to market jurisdictions. The move implied a strong impact for working together to tackle global warming. However, since the summit, several countries have shown poor compliance and this has exposed the lack of commitment on climate change and carbon pricing mechanisms in order to achieve net zero emissions by 2050 (including Mexico). 

Reaching net zero emissions will likely require the use of a global carbon tax floor to ensure that a deadline in 2050 can work and in connection with the last paragraph, none of the countries bowed for establishing a global carbon tax as they did with the global minimum tax – marking a discouraging situation. 

As of December 2021, two of the most important Mexican tax policy measures comprises of a carbon tax and levying green taxes, which only have been implemented/proposed for specific pollutant enterprises, such as mining companies, with the aim to fight global warming challenges. 

The most important Mexican pollutant companies are located in Zacatecas, Coahuila, Sonora and Michoacán, the country’s biggest silver, zinc, gold, iron and copper producers, which deposit pollutants in the soil, certain types of open pit mining, atmospheric emissions and waste storage in landfills. 

In this sense, Zacatecas was the first state to levy green taxes in 2017. Other states have sought to follow the footsteps of Zacatecas by proposing to levy their own local ecological taxes, however with little or no success. 

In the latest blow for governments seeking to levy green taxes, the Mexican Supreme Court of Justice declared that the environmental taxes targeting extractive industries in Michoacán and Sonora were unconstitutional, under the ground that the proposed taxes for 2021 violated the principle of fiscal justice. 

Furthermore, states levying green taxes in Mexico have faced several issues, among others, the amparo suits filed by private companies and which are still pending to be solved, the appeals filed by the federal administration against the levies, arguing that green taxes can only be taxed by federal authorities and the inability to collect said taxes by local states.

Steps that will be needed to fulfil commitments

Notwithstanding the fact that Mexico has failed to fulfil its global environmental commitments – even more with the new administration’s recent policy decisions – a huge change should be foreseen from the commitments made at COP26, and the following steps would necessarily imply a new analysis and proposed changes to the energy sector. 

Even though the scenario remains uncertain, the new Mexican tax policies should aim to achieve environmental effectiveness, have an equitable and distributional impact, a broader tax system impact, macroeconomic effects, better compliance and administration, policy processes and consistency. 

Mexico needs a comprehensive mitigation strategy in connection with carbon taxes, complemented by other measures to enhance effectiveness and acceptability, likely for the power industry, transportation, and construction sectors, which are less efficient than carbon taxes but might be scaled up more rapidly as they impose smaller burdens on households and enterprises, in order to address all fossil fuel emissions which rises quickly over time. 

Notwithstanding the above, the current policies are likely to fall short of its 2030 emission plans, Paris-aligned targets and recent COP26 commitments, since no radical change is foreseen in the country. Especially in lieu of the coming years with the current administration’s energy plans – however there is still hope for Mexico to change its perspective. 

In this sense, besides reflecting supply and climate costs, broader reforms could also reflect local environmental costs in fuel prices, including local air pollution, a concerning matter which implies the risk of premature mortality from cancer, strokes, heart, and lung disease for exposed populations. 

In addition, even with a strong carbon pricing, additional measures are needed to liberalise power generation and support investment in low-carbon technologies, thereby facilitating Mexico’s clean energy transition. 

A comprehensive mitigation strategy could have carbon tax as its centrepiece and a variety of other complementary measures to enhance effectiveness and acceptability. 

These additional measures include: (i) reinforcing fees or regulations at a sectoral level; (ii) public investment in clean energy infrastructure networks and market reforms (e.g. in power generation) to enhance competition and investment; (iii) productive and equitable use of carbon pricing revenues; (iv) transition measures to assist vulnerable households, workers and regions; (v) measures to address industrial competitiveness; and (vi) pricing of other emission sources beyond energy-related emissions. 

Looking ahead 

The promises made by Mexico in COP26 should be the turning point for the country in order to step up its environmental commitments. 

The recent decisions and amendments proposes by the government imply a risk of not achieving the climate targets adopted by Mexico, however the position reflected during COP26 gives us hope that the country is committed with a climate mitigation strategy. This make us think that Mexico will try to make an effort to combat climate change and develop strategies to generate energy from clean sources.

The next steps cannot be ensured and the scenario remains very unclear. However, by the end of 2022, once the new climate targets of Mexico at COP27 are revealed, there will be a much better idea of whether and to what extent the country will be able to avoid exceeding the temperature threshold and to what kind of measures it takes against global warming.

The only fact is that in the coming years, Mexico must increase its emission reduction targets by 2030 to align with 1.5°C, and stronger approaches are needed to hold the commitments made in Glasgow during COP26.  

 

Federico Scheffler

2e1896940f8b405a97f98ec87e4e0c8f

Partner

Galicia Abogados 

T: +52 55 5540 9200

E: fscheffler@galicia.com.mx

Federico Scheffler is a specialised Mexican corporate and tax lawyer. He has been a partner in the tax practice at Galicia Abogados since 2018.

Federico has a focus in mergers and acquisition (M&A) transactions, venture capital, corporate and project finance, capital markets and in determining the tax implications derived from the said operations. His expertise has been recognised by different international publications. He is a member of a number of institutions, including the Mexican Bar Association and the International Fiscal Association (IFA), where he is part of the Young IFA Network (YIN). He is also part of the network of mentors of Endeavor Mexico, a high-impact entrepreneurship network.

Federico has a master's degree in business administration (MEDEX) from IPADE, postgraduate studies in tax law from Universidad Panamericana, and a bachelor's degree in law from Instituto Tecnológico Autónomo de México (ITAM).

 

Ana Elena Domínguez 

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Associate

Galicia Abogados

T: +52 55 55 40 9200

E: aedominguez@galicia.com.mx

Ana Elena Domínguez is a tax associate at Galicia Abogados, advising on national and international tax matters. 

In recent years, Ana Elena has been specialised in consulting and representing clients in tax matters, both in Mexico and abroad, on various types of operations and transactions. Her expertise is mainly focused on estate planning of individuals and legal persons as well as for enterprises, in order to provide adequate protection, disposition and diversification of their assets, as well as the advice in different corporate restructurings, mergers, spin-offs and acquisitions. She is an active member of the IFA Mexican branch, has authored several publications both nationally and abroad, and is currently a professor of Mexican tax subjects.

Ana Elena holds bachelor’s and master’s degrees from Universidad Panamericana. She also has an LLM in international tax law at the Vienna University of Economics and Business, and has studied various postgraduate courses at New York University, Rey Juan Carlos University and at ITAM.

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