Puerto Rico Gov. Alejandro García Padilla proposed a tax overhaul intended to reduce tax evasion and promote economic growth as the commonwealth looks to repair its finances and junk-rated credit.
If adopted, the tax overhaul would shift the focus of island's system from income to consumption taxes. The proposed income tax would apply to individuals earning $40,000 or more a year, up from the current $20,000 minimum, according to the governor. Couples wouldn't have to pay unless they made $80,000 or more.
At the same time, the commonwealth's 7% sales and use tax would be replaced by a 16% value added tax, Government Development Bank President Melba Acosta Febo said. While sales taxes are charged only by retailers, value added taxes are charged all along the supply chain.
The government has been developing the new tax proposal for at least a year as a way to spur an economy that contracted from 2006 to 2011 and has remained weak ever since.
The tax package is also a response to what is widely acknowledged to be a significant tax evasion problem.
"We currently have a tax system that penalizes work and productivity while encouraging evasion," García Padilla said. "It is inefficient and unfair. The current system punishes the middle class and the poor that work so hard to provide for their families."
García Padilla pointed out that only 12,000 people file tax returns for $150,000 and up in income, which stands in contrast to the many luxury cars and houses in the commonwealth. Many self-employed illegally underreport their income and/or use legal exemptions to minimize it, a source close to the governor said.
The new tax system will mean that fewer potential taxpayers will avoid paying through tax-evasion or the use of exemptions, Treasury Secretary Juan Zaragoza G-mez told The Bond Buyer.
Puerto Rico's government realizes that most tax systems based on consumption taxes take larger shares of income from poor people than from high earners. To address this, the new system would include distributions of money to poor and elderly people, the governor said.
Prescription medications, groceries, rents, mortgages, and public higher education charges would be exempt from all taxes.
"With this tax system overhaul we can help direct the island's revenues towards the future and ensure that we will borrow less, pay our current debts, and pay down the debt previous administrations committed to without the appropriate means for repayment," the governor said.
The new tax system will also eliminate the corporate gross receipts tax (Patente Nacional) that larger companies had to pay.
The consulting firm that largely created the proposed tax overhaul, KPMG, said it would promote economic growth, Acosta Febo said. There have been countries that have achieved economic recovery with the aid of the introduction of a value added tax.
The new tax system will mean the Treasury will receive 850,000 fewer tax returns. Because of this, the Treasury can use its energies to focus on cracking down on evasion more, Acosta Febo said.
A source close to the governor said she believed the roll out of the new tax system would take up to 18 months. She also said that Zaragoza believed that up to 24 months may be needed.
The proposal arrives three business days after a federal judge ruled the commonwealth's Recovery Act, passed last year to allow public corporations to restructure their debt, was unconstitutional. As Puerto Rico's general obligation bond yields surged in the secondary market, the legislature eased yield restrictions on a planned $2.95 billion bond sale amid speculation that the sale might have to be delayed.
In mid-January the Puerto Rico government adopted a measure to sell the bond, backed by higher taxes on imported oil to support the Puerto Rico Infrastructure and Finance Authority sale of the bond.
The Senate included provisions whereby the coupon could be no higher than 8.5% and the price no lower than 93 cents on the dollar. On Monday and Tuesday the Puerto Rico Senate and House of Representatives voted to eliminate the floor on the price.
Secondary market yields on Puerto Rico general obligations have traded at times over 10% for some maturities since the court ruling on the Recovery Act.
The governor hasn't signed the bill to eliminate the limit on the discount and has not yet received the bill from the legislature. However, a source close to the governor said she believed he supports the measure.
The proceeds from the bond will be used primarily to pay the debt of the Puerto Rico Highways and Transportation Authority to the Government Development Bank for Puerto Rico. In this way it will kill at least two birds with one stone - remove financial strain from the PRHTA and improve the GDB's liquidity.
Acosta Febo told The Bond Buyer she anticipated the bond would be sold this quarter.
