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  • Writer's pictureThe San Juan Daily Star

Fiscal board: PR’s tax expenditures eclipse those of the leading state

Treasury Secretary Francisco Parés Alicea

By The Star Staff

Puerto Rico has 438 tax expenditures with a total magnitude of $23.7 billion, an increase from $22.5 billion in 2017, and over four times higher than the U.S. state with largest tax expenditure over economic output, the Financial Oversight and Management Board said.

The oversight board said the amount in tax expenditures or revenue losses may be over $1 billion more because the island Treasury Department did not include property tax and municipal license tax incentives as tax expenditures. Puerto Rico filed for bankruptcy in 2017 to restructure some $70 billion in central debt and some $50 billion in pension debt.

The remarks by the oversight board were made in a June 10 letter to Treasury Secretary Francisco Parés Alicea regarding the Puerto Rico Tax Expenditure Report for Tax Year 2023. Tax expenditures are revenue losses attributable to provisions of Act 1 of Jan. 31, 2011, which is the Internal Revenue Code for a New Puerto Rico, that deviate from the tax structure’s benchmark law. The revenue loss could be due to a special exclusion, deduction, exemption, credit, a preferential rate of tax, or a deferral of tax liability.

While the oversight board had good things to say about the contents of the tax expenditures report, it also noted that almost two-thirds of the expenditures, or $14.8 billion, are in the form of preferential tax rates for foreign-owned manufacturing companies offered as incentives for operating in Puerto Rico. Other large tax expenditures include sales and use tax (IVU by its Spanish acronym), exemptions on food ($820 million), health services ($785 million) and educational services ($717 million), and individual income tax preferential rates under Act 22 ($342 million).

The oversight board told Parés Alicea in a letter dated June 10 that comparisons “clearly demonstrate the rather extreme position of Puerto Rico in allowing ad hoc departures from its normative tax structure.”

“Puerto Rico’s tax incentives produce far greater tax base erosion than present in virtually every other comparison jurisdiction,” the board said in its letter.

Expressed as a share of the gross domestic product (GDP), Puerto Rico’s tax expenditures are nearly four times or six times those observed in Michigan, the jurisdiction with the next largest ratio of tax expenditures to economic output and are also at least seven times larger than those offered by states with relatively low per-capita incomes such as Alabama, Tennessee and Mississippi.

“In particular, Puerto Rico has (by far) the highest corporate income tax expenditures mainly due to preferential tax rates for foreign corporations, which are not common in U.S. states,” the oversight board said. “Tax expenditures of this magnitude put significant direct pressure on the sustainability of Puerto Rico’s underlying tax structure.”

The widespread, ad hoc incentives force the commonwealth to impose a highly distortionary rate structure, with corporate tax rates as high as 37.5% on the remaining business base, the board noted.

“Further, due to the negotiated nature of the tax structure and final tax liability, there is considerable uncertainty and high transaction costs imposed in the process,” the oversight board said. “Uncertainty, transaction costs and a rather predatory default tax structure produces a very poor business investment climate.”

For prudent fiscal policy, the magnitude of such tax expenditures should be strictly limited, and the tax structure should be reformed to broaden bases and reduce rates across all major tax instruments, the board noted. That has been demonstrated to be a far more successful strategy for promoting economic development, it said.

As a first step, “Puerto Rico should attempt to align both the size and the distribution of its tax expenditures to the best performing benchmarked states, with an ultimate goal of eliminating any tax expenditures for which unequivocal evidence for their retention cannot be established and then rationing resources directed to those which remain in a manner that produces the highest return to the development objectives of the Commonwealth,” the oversight board said.

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