The Tax Reform Act for Puerto Rico presented by Governor Alejandro Garcia Padilla is the significant change Puerto Rico needs to stimulate the commonwealth's economic development and confront the Island's fiscal challenges.
It is a major transformation of the way the Island obtains its revenues. It is an opportunity to fight tax evasion and to eliminate the unfair burden placed on the working class under the current income tax system. The bill aims to shift revenue now obtained through income taxes, to revenue obtained through a tax imposed on goods and services. Bill 1304 includes a major reduction in income taxes for the approximately 850,000 Puerto Ricans that make up the Island's middle class, and shifts the weight to a Value Added Tax, which by nature regulates itself.
In the past, other government administrations had balanced the budget by increasing debt. Most of the additional income was used for the payment of recurring operating expenses and refinancing old debt - we weren't making any progress. During the period from 2009-2012, the past administration issued approximately $16.5 billion in new debt. In those four years they issued as much debt as was issued in Puerto Rico in the 50 years from 1941 to 1991. This way of running government finances has undermined our ability to allocate more resources to the development of our economy.
Aside from endangering our future generations, this pattern of chronic indebtedness paired with our fragile economy has degraded the commonwealth's credit to a speculative level. This has raised the cost of financing for the Government and has limited our access to capital markets.
Our Caribbean island of 3.6 million people is struggling with debt of more than $70 billion, an economy that has been near recession for eight years, and a budget balanced for the first time in two decades. We have more resources than we are tapping into. Some estimates say up to 25 percent of Puerto Rico's economy is informal, and that there is an underground economy of $20 billion.
In response to criticism of government spending, and the opposition's demands to reduce public payroll before implementing a VAT, I would point out that General Fund expenditures have been steadily reducing. The General fund expenditures have reduced from an average of $10.962 million during fiscal years 2009-2012, to $9.885 million in fiscal year 2013 and $9.376 million in fiscal 2014. This implies a reduction in expenses of $ 1.586 million or approximately 14.47 percent. The number of public employees paid from the General Fund has also declined dramatically, from 139,640 jobs in 2007 to about 89,600 in December 2014, a reduction of about 34 percent in comparison to incumbency during 2007 and 2014, and approximately 12 percent when compared to the months between December 2012 and December 2014.
The VAT system exists in over 160 countries around the world. In fact, seventy five percent of Puerto Rico has been operating under a VAT-like system since August 2014, when we started the collection of Service and Use Tax (SUT) at the docks. We implemented a VAT in terms of assets, although we didn't call it by its name, we already live under VAT in practice. And we have seen that it works.
The remaining 25 percent of the VAT implementation will be introduced in phases, and will include a restructuring of several divisions of the Treasury Department. Currently, the Treasury division has about 1,000 employees, of which 176 are auditors and 215 are assigned to the payroll processing area. By eliminating the accounting that must be done for about 850,000 income tax returns, it is expected that part of this staff, mostly dedicated to processing refunds, will be relocated to other duties including assisting in the collection of VAT at the docks, overseeing credits, and securing the VAT refunds process.
Puerto Rico's tax transformation includes regressivity relief for lower income citizens and our growing elderly population. This is a fundamental part of the transformation, to make our tax system work in our reality. The Treasury Department hired economist Maria Enchautegui, from the Urban Institute, to work on a survey of the conditions of low-wage workers. She is completing profiles based on criteria including age, dependents, income, and family composition. The model is being constructed based on household and relevant databases, including exempt goods and services. That model will be used to develop recommendations for determining the amount of regressivity relief. Some of the results of this analysis will be inserted in the Act as an amendment, and some results will be included in regulations.
To say you are against the VAT in Puerto Rico disregards the most important part of the proposed Tax Transformation - the unprecedented reduction in income tax rates. Supporting the VAT for Puerto Rico backs a healthy taxation system, a system which is used by 19 of the 20 largest economies in the world.
Melba Acosta Febo is president of the Government Development Bank for Puerto Rico.
