By The Star Staff
The Financial Oversight and Management Board has asked the island government to overhaul its tax system so as to limit tax incentives.
The call for tax reform is part of its fiscal plan approved this week.
“A comprehensive review of Puerto Rico’s revenue structure must be completed as part of a tax reform process because Puerto Rico’s income tax structure (for both individuals and corporations) is complex and opaque,” the oversight board said.
Over the past several years, the Puerto Rico government has improved the island’s tax system by changing information reporting requirements and improving the organization of tax information and forms, including the digitization of certain processes. Significant reform is still, however, required because Puerto Rico’s current tax system has historically suffered from structural complexity, instability, internal inconsistency, inefficient administration, and inadequate enforcement, the oversight board said. There have been at least 11 major revisions to Puerto Rico’s tax code since 1994, including at least six adjustments since 2013.
As a result, the board said, the government must continue efforts to reduce the tax system’s complexity, enhance equity, increase transparency, reduce tax administrative and compliance costs and maintain, if not enhance, revenue.
Effective revenue systems are based on taxes that generate sufficient revenue to fund needed public expenditures, are simple to administer, are transparent, are perceived as fair and equitable, and encourage economic efficiency and growth, the oversight board noted. Effective tax systems that have a broad base and low rates generally conform to those precepts, and generally avoid targeted tax incentives unless those incentives are supported by clearly demonstrated economic or social benefits, the board said.
Furthermore, a broad base combined with low tax rates reduces the potential gain from tax evasion or avoidance. Promoting compliance is another central feature of properly designed revenue systems, the oversight board said.
An overly complex and poorly designed tax structure cannot be implemented effectively and, therefore, compliance and enforcement typically fall short, the board said. Beyond simplicity, perceptions of fairness are another important factor for promoting compliance and enforcement.
Because revenue can be raised from a variety of different sources, it is important that Puerto Rico’s mix of tax sources be carefully considered so that government programs are not excessively reliant on sources that may be uncertain or volatile or to a degree which excessively distorts economic activity or taxpayer choices, the oversight board said. This is particularly relevant because Puerto Rico’s tax regime disproportionately relies on two tax sources, income taxes and sales & use taxes, which represented roughly 73% of General Fund revenue collections in fiscal year 2022.
Unlike the federal tax code, Puerto Rico’s tax brackets are fixed and do not adjust for inflation. The tax code also includes numerous targeted deductions, exemptions, credits, and special rates that benefit narrow groups of taxpayers while potentially distorting the allocation of resources and reducing revenue available to fund needed public expenditures, the oversight board pointed out. These incentives are often privately issued and are not always disclosed publicly. At the same time, businesses faced with paying statutory corporate income taxes face a relatively high tax burden, as Puerto Rico has not followed the global trend of reducing statutory corporate income tax rates over the last 20 years.
Similarly, Puerto Rico’s 11.5% sales and use tax is higher than the rate imposed by other U.S. jurisdictions, though there are multiple reductions and exemptions to the rate.
“In addition to reviewing Puerto Rico’s revenue structure, a detailed review of tax expenditures must also be considered because Puerto Rico issues more than 400+ tax incentives with total foregone revenue projected to exceed $23 billion in 2023,” the oversight board said. “Any tax reform considered by the government should establish rates, credits, deductions, and other alterations to tax structures firmly in the tax code. It should also limit the use of negotiated rates or incentives. Tax incentives, moreover, should be evaluated based strictly on a return-on-investment criteria and those that do not provide a significant positive return should be eliminated or reduced.”
The oversight board said it has long advocated for a truly comprehensive tax reform that can contribute to Puerto Rico’s competitiveness and contribute to economic growth.
“Having now exited the restructuring process, it is finally time to evaluate opportunities for broad-based, holistic tax reform,” the board said. “At the same time, any potential reform must be fiscally responsible, meaning it cannot lose revenues in the process.”
“Therefore, any tax reform or tax law initiative that the Government undertakes or pursues during a year within the 2023 Fiscal Plan period must be revenue neutral,” the oversight board added.
Each tax measure must also include confidence-building elements, such as behavioral adjustments and reasonable capture rates, the board noted.
“To ensure revenue neutrality, the implementation of any tax law initiative must occur sequentially, with the Government ensuring that initiatives are paid for before rates are reduced,” the board said. “Enforcement mechanisms that yield additional revenues must be part of any tax initiative package that results in a tax revenue decrease to prevent a scenario where tax reductions are not accompanied by sufficient offsetting revenue measures identified in the enabling legislation. Any potential tax reform should also be inextricably linked to the economic development strategy while preserving resources needed to fund essential services.”
The oversight board, executive branch and Legislature have not yet been able to agree on far-reaching proposals that meet this criterion. Nevertheless, the oversight board said it is committed to pursuing fair and competitive solutions that can improve the tax climate for individuals and businesses while also maintaining fiscal stability.