THE EFFECTS OF PREFERENTIAL VAT RATES NEAR INTERNATIONAL BORDERS: EVIDENCE FROM MEXICO

Most goods and services in Mexico are subject to a 16 percent value added tax (VAT). However, within 20 kilometers of the border with the United States, the VAT rate is 11 percent. This preferential rate was implemented by the Mexican Department of Revenue to reduce cross-border shopping in the United States. However, the tax differential also creates an unusual distortion within Mexico, encouraging Mexicans to travel to the preferential tax zone for shopping. This paper performs an empirical test of tax avoidance using the Mexican Economic Census, comparing towns on either side of the 20 kilometer threshold using a regression discontinuity design. The analysis provides evidence of a modest but statistically significant distortion in economic activity toward the preferential tax zone.