Study: Impact of incentives laws has been modest, but let them stay

By The Star Staff

Act 20, the Exports Services Act; Act 22, the Law to Promote the Relocation of High-Net Investors to Puerto Rico; and Act 273, the International Financial Center Regulatory Act have had a modest but effective impact on the economy, a study commissioned by the Economic Development and Commerce Department (DDEC by its Spanish acronym) has found.

“We do not recommend the repeal of Acts 20, 22, and 273. Rather, we recommend overhauling them to maximize their potential,” noted the study conducted by Econometrika Corp., which is headed by José Caraballo Cueto, an economist and University of Puerto Rico professor.

The study comes as the island House and the Senate this week are slated to hold hearings on the effectiveness of the laws. Act 22 of 2012 gave complete tax exemption on capital gains to individuals who move from any country to Puerto Rico. Act 20 of 2012 reduces the tax rate on exporting services to 4%, and Act 273 of 2012 also decreases the tax bracket to 4% to international financial organizations.

The study found that from 2012 to 2017, the laws created some 33,000 jobs, causing a 3% hike in employment and had a total production of 2%. The study used econometric methods of causal inference to yield its results.

According to the DDEC, by 2017 there were 1,332 individuals with decrees under Act 22 and 781 under Act 20. However, the number of applications has grown exponentially. In fact, in 2020, the DDEC reported 579 decrees having been approved for Act 20 and 710 for Act 22.

Regarding Act 273 of 2012, the number of decrees is much lower than for the other laws and has declined. By 2017, only 32 corporations had decrees under Act 273.

“Basically, the study measured what would have happened in the absence of these laws, which, although they have had a moderate impact on the economy of Puerto Rico, without them, the loss of jobs during the past decade would have been greater,” DDEC Secretary Manuel Cidre said. “The economic activity index would have been 2.64 points lower.”

At the same time however, the study shows that the impact could be greater, the DDEC secretary said, “if we can create the ideal conditions to attract real investors.”

“Anyone who has no intention of investing and contributing to our economy should pay a higher tax than if he is investing and creating jobs,” Cidre said.

The study makes some recommendations to improve the supervision of the decrees, such as the requirement of the annual delivery of documents 1040R and 940R in order to know in an updated way the real payroll of investors with a decree, he said.

“Definitely, supervision has to be more active,” Cidre said. “We have directed our efforts toward that in these months.”

To that end, Carlos Fontán, executive director of the Office of Business Incentives at DDEC, noted that thanks to the compliance process under the established decrees, 1,086 individuals have been identified and notified about possible non-compliance.

“This will be an essential recurring process of the Office of Incentives. We also began an audit process where we will ensure, not only compliance with the delivery of the Annual Report required by the incentive laws, but also compliance with all other terms and conditions of the decrees,” Fontán said. “As part of these efforts, we have already identified over 60 decrees that may be subject to revocation. We are improving technological processes and automating them, to facilitate data collection, speed up audits and receive annual reports automatically through the Single Business Portal. Since 2012, no decrees have been audited under Law 22. This is the first time that an effort of this magnitude has been carried out.”

“We are also beginning to be more rigorous in evaluating the granting of incentives, to ensure that the applications we approve represent the best interests of Puerto Rico,” Fontán added.

Cidre said that “[p]ositive progress has been made to obtain compliance with Acts 20 and 22 and maximize their performance, ensuring the best interests of Puerto Rico.”

“In parallel, our team is working on the report required by Law 60, which will measure the return on investment of all incentives, based on what the recipients of these incentives pay and contribute to the treasury,” he said. “It is time for us to measure and maximize each of the incentives that occur in Puerto Rico. This report will be ready to be published and presented to the country in September.”

Caraballo Cueto made certain recommendations to improve the performance of the laws.

Specifically, he proposed that policymakers condition participation under Act 273 and Act 20 to the creation of at least 10 new jobs, establish a minimum capital gains tax rate for Act 22 of 12% and raise property taxes for luxury properties to avoid the free rider problem, which is when an economic agent enjoys public goods but does not pay for them.

However, the capital gains tax rate can be reduced to 5% if the investor hires a minimum of five employees and invests $2 million or more in renovations of existing properties or in local assets. In doing so, policymakers can make sure that grantees really have an incentive to invest, he said.

The UPR economist also suggested denying the Act 22 incentive to individuals who do not want to do business in Puerto Rico, have a net worth lower than $10 million, or will transfer less than 25% of their capital to the island. These requirements would ensure that participants create economic activity, he said.

Additionally, investments in a primary residence should not be considered as part of the investment requirement, and second homes located in fastest-growing areas such as Old San Juan, Isla Verde, and subdivisions in Dorado, Vieques and Gurabo, among others, should not count as investment requirements. Many of those areas still qualify for the opportunity zones incentives, Caraballo Cueto said.

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