Puerto Rico Gov. Alejandro García Padilla's proposed tax overhaul, key to his plan to shore up the commonwealth's ability to pay debt service, has come under fire.
Groups ranging from doctors to truckers to mayors have voiced opposition to a proposed shift from a 7% sales tax to a 16% value added tax, part of an overhaul that would also slash income taxes and eliminate a corporate receipts tax paid by large companies.
The political uproar may force the government to abandon the VAT plan in favor of an increase in the sales tax rate, according to Municipal Market Analytics managing director Robert Donahue.
On Friday, Puerto Rico House of Representatives Speaker Jaime Perell- said that the governor's original proposed tax reform didn't have the votes to pass in the House, according to Perell-'s spokesman. Perell- is the leader of the governor's party, the Popular Democratic Party, in the House.
Puerto Rico House Representative Rafael "Tatito" Hernandez, who chairs the House Treasury and Budget Committee, was more optimistic about the proposal. He said much of the proposal will be passed, though with some amendments.
Debt service for the island's general obligation debt is scheduled to rise by $600 million next year, Hernandez said. To make that payment the government will combine tax increases with some limited budget cuts, he said.
Though the tax changes may ultimately yield an additional $1.2 billion a year in General Fund revenue, Hernandez said he expected significantly less than this in the next fiscal year.
The commonwealth has already had a levy similar to a value added tax since July 2014, he said. In that month the government started collecting sales taxes on goods arriving at its ports before they were distributed to wholesale and retail outlets.
The most important addition to the tax will be a tax on services. This should start in January 2016, Hernandez said. The value added tax proposal will be amended to exclude certain things, like healthcare, he said.
Hernandez said he expected the government to complete work on the tax reform by the end of the month.
The governor has presented the tax reform partially as a way of cracking down on what is acknowledged to be a tax evasion problem on the island. Not counting the illegal activity like drug trafficking, the Puerto Rico Treasury estimates 25% of island's economy doesn't pay taxes. This compares to tax evasion rates of 13% to 19% in the 50 states.
"The general thrust of the tax reform is positive," said Vicente Feliciano, president of Puerto Rico-based Advantage Business Consulting. Many self-employed and small-businesses accept cash as payment to evade income taxes now. Introducing a VAT tax would force these people to pay significant taxes for the goods they buy both for their businesses and for their personal use, Feliciano said.
As for the opposition that the tax reform has generated, Feliciano noted that only about 40% of Puerto Ricans are earning an income at a job. The remaining 60% of society is worried about the reform's increase in consumption taxes, he said.
The governor has said that the tax reform would have a measure similar to the earned income tax credit in the 50 states of the U.S. To combat a regressive nature of a tax system leaning more on consumption than income taxes, the government would send money to the working poor three times a year to supplement their income. The government has at times indicated that this tri-annual supplement would also be delivered to retired old people.
The opposition the tax reform has encountered is at least partly due to the fact that the governor's presentation of it has been ineffective and murky, Feliciano said. If the governor was honest he would admit that he was not just introducing a tax reform but also a tax increase. However, if he were to do that he'd have to admit that $600 million of the increase was to pay for an increase in debt service, Feliciano said. And a tax hike for this purpose is "sensitive," he said.
Feliciano noted the governor is seeking the additional $600 million beyond the $600 million needed for increased debt service.
The government may need more than $1.1 billion to meet pending needs for the next fiscal year.
In the current fiscal year, the government is using $270 million in capitalized interest from the March 2014 bond sale. There is no capitalized interest set aside to benefit fiscal year 2016. In addition, revenues are currently coming in 2.5% below projections. If revenues continue to come in 2.5% short, the government will end the fiscal year $239 million short of estimates.
