Puerto Rico's leaders reached a major tax and spending pact Friday morning that would achieve a balanced budget but may hurt the island's economy.
Puerto Rico Gov. Alejandro García Padilla and legislators from his Popular Democratic Party reached the agreement after reportedly meeting 10 hours on Thursday afternoon, evening and Friday morning.
According to a professional who works in the governor's office, the group agreed to increase the island's sales and use tax to 11.5% from 7% in the 30 to 45 days that followed formal approval of the measures. Of the 11.5%, a 10% portion would go to the commonwealth government and a 1.5% portion would go to the municipalities.
Over the nine or so months following approval, the sales and use tax would be replaced by a value added tax. A sales tax is only charged by retailers whereas value added taxes are charged all along the supply chain. The island's sales tax already has elements of a value added tax.
Whereas the consumer tax is currently only on physical products, in the near future a 4% tax on services will be introduced, the source close to the governor said.
The value added tax will exempt health services, education, prescription drugs, rent, mortgage payments and utility payments.
The legislators agreed to introduce a new tax on the transfer pricing of large chain stores like Walmart. Some legislators have suggested a new tax on soda drinks but no decision was made on this.
Taken together the tax measures would be expected to bring in $1.2 billion per fiscal year, according to the source in the governor's office. Lilliam Maldonado, spokeswoman for Puerto Rico House Representative Jesús Santa Rodriguez, said the measures would bring in $1.5 billion per fiscal year.
The legislators also agreed to cut $550 to $600 million in discretionary spending from the fiscal year 2016 budget, the source in the governor's office said. This budget is expected to be for $9.8 billion, up from $9.56 billion in the current fiscal year.
In early February the governor proposed a tax overhaul that shifted to a greater emphasis on consumption taxes and less reliance on income taxes. It would have included a value added tax of 16%, a provision that ran into opposition from a broad spectrum of Puerto Rico society.
Ultimately, the governor reached an understanding with Puerto Rico House of Representatives President Jaime Perell- to support a 14% VAT plus reduced income taxes. On April 30 the Puerto Rico House defeated this measure 28 to 22, with 22 members of the PDP party voting in favor and six voting against it. All 22 of the opposition New Progressive Party legislators voted against it.
The governor has indicated that the government needs to come up with more than $1 billion in spending cuts and/or revenue increases to achieve a balanced budget in fiscal year 2016.
There were no cuts in income taxes included in the pact agreed upon Friday morning, according to the source close to the governor. In the governor's original proposal in February there were rebates to be delivered to those making low incomes three times a year, to make up for the increased consumptions taxes.
Advantage Business Consulting President Vicente Feliciano said Friday's proposal included $300 million in income tax reductions or rebates. The source close to the governor said there was no money for the income tax reductions but was unsure about the rebates.
The agreement on Friday morning was informal. None of the agreement's measures will go into effect until the Puerto Rico House and Senate approve them and the governor signs them.
Feliciano said that while Friday's agreement was credit positive for Puerto Rico it will also be economic negative for it. The adjustment of spending and taxes are equal to 2% of the Puerto Rico gross national product. This is a "very large" adjustment, Feliciano said. However, he said it is too early to make a precise forecast of the adjustment's impact on the economy.
