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Idea Of Sales Tax Gaining Momentum

There is a growing sentiment among private sector representatives and professional organizations to replace archaic 6.6% excise tax system


May 16, 2002
Copyright © 2002 CARIBBEAN BUSINESS. All Rights Reserved.

Last week’s permanent injunction issued by U.S. District Court Judge Carmen Vargas Cerezo barring the local Treasury Department (Hacienda) from enforcing Law 13, and the public outcry to the recently approved excise tax hikes on sport utility & luxury vehicles, cigarettes, beer, wine, and spirits have renewed the debate of whether it’s time to replace the current, but archaic excise tax system.

Approved by the Calderon Administration in June of last year, Law 13 imposed an excise tax collection scheme on air cargo carriers, thus affecting how these companies could perform deliveries of taxable goods in a timely fashion to local customers.

Vargas Cerezo’s decision suddenly creates an unexpected $100 million shortfall in the government’s fiscal year budget for 2003, which begins July 1. The government has appealed the decision, although it is unlikely it will be reversed, according to industry sources.

Additionally, legislation was recently approved to hike the tax on sport utility & luxury vehicles as much as 40%, as well as for significant tax increases to cigarettes, beer, wine, and other spirits–the so called sin taxes–as a means to balance the budget. The measures await Gov. Sila Calderon’s signature to become law.

Both issues–the $100 million budget shortfall and the significant increase in sin taxes–have raised the issue of replacing the cumbersome 6.6% general excise tax with either a sales tax or a value added tax system.

Under the current excise tax system, taxes on consumer goods are collected at the port of entry and paid by the distributor, who then jacks up the price to cover for the excise tax. In a sales tax system, taxes are collected at the retail level and paid by the consumer at the point of sale.

Searching for an alternative

"During the legislative excise tax increase process, many members in the industry talked about the possible implementation of a sales tax. All agree that it is a fantastic idea, one that will benefit everyone–government, businesses, and consumers," consumer products distributor Mendez & Co. President Luis Alvarez told CARIBBEAN BUSINESS.

Alvarez firmly believes that the implementation of a sales tax in Puerto Rico would be highly beneficial to the island, as it would eliminate all the hassles related to the tax on importers and manufacturers, commonly known as the general 6.6% excise tax or arbitrio general and generate additional revenue for the government by including most of the activities of the underground economy that are currently excluded.

"There are a lot of things today that are not being taxed and should be," said Alvarez. "A sales tax system would be a more balanced and just way for the government to generate more revenue."

Atilano Cordero Badillo, chairman of Empresas Cordero Badillo–the parent company of Grande Supermarkets–agrees with Alvarez.

Cordero Badillo said that with a per capita income of $11,500, an annual government budget of $21 billion, and an underground economy estimated to be equal to the formal economy, the only way to solve the island’s underground economy and tax evasion problem is through the implementation of a sales tax system.

"The salaried, hard working, honest people are the ones carrying most of the island’s large tax load," said Cordero Badillo. "I believe a sales tax system would solve much of the tax evasion problems associated with an underground economy."

Another option to the excise tax is the value added tax, which essentially would have the same effect that of a sales tax, but it is collected at the distributor level.

In fact, the value added tax has been adopted by practically every country in the world except the U.S., although states such as Michigan and North Carolina have implemented some form of value added tax, noted Economist Ramon Cao Garcia.

Advantages, disadvantages

According to Cao Garcia, the sales tax system would have some significant advantages over the existing general excise tax.

"In a sales tax system you collect the taxes at the retail level, which automatically eliminates the cascading effect. This allows for greater tax revenue collection while using the same tax rate or the same revenue collection at a lower tax rate," explained Cao Garcia.

The cascading effect refers to the price markups a product experiences when going through the distribution channel process, from distributor to retailer to consumer.

By eliminating the cascading effect, it is much easier and more precise to identify those activities or products to be taxed. This generates less inefficiency during the economic activity and widens the tax base, said Cao Garcia.

"There is less distortion on the products’ relative prices as there are in the general excise tax system," said Cao Garcia.

One drawback of the sales tax, Cao Garcia said, is that it requires a more complex system for its administration, as the government would have to audit the approximately 15,000 formal retail establishments on the island versus a few dozen distributors, Cao Garcia indicated.

"That’s probably the main reason people have criticized the excise tax system for so long, but has not been changed," said Cao Garcia.

Cao Garcia believes it will take the government at least two years to implement a sales tax system, but has serious doubts about the government’s capacity to administer it. He said it would be easy to audit large retail establishments at shopping malls, but harder for smaller ones in remote locations.

"We have the technology to accept debit and credit cards in practically everywhere, but cash transactions will not be reported, thus opening a window for tax evasion," commented Cao Garcia.

Nonetheless, Cordero Badillo believes a sales tax system can be implemented in Puerto Rico, although it is not too sure that any of the political parties have the will to implement it.

"The island is electronically and technologically ready to implement a sales tax system. All government auditors will shift their efforts to audit retailers," said Cordero Badillo. "It can be done. Whether there’s the political will to do it, that’s another matter."

CPAs to commission study

"A sales tax could be the solution to Puerto Rico’s tax reform," said Puerto Rico Society of Certified Public Accountants President Raul Rodriguez. "The Society’s Foundation will commission a study on the possible implementation of a sales tax in Puerto Rico."

The goal of the study would be to measure how a sales tax system could efficiently fight the underground economy and if it would be fairer across all income levels, which Rodriguez stated everyone knows the current system is not.

Rodriguez contends that the implementation of a sales tax system on the island is just the beginning of a much wider tax reform that eventually will need to be addressed and would involve the municipalities and increases to property tax rates, which are based on 1956 numbers.

"It is clear the under the current system, we have been unable to reduce the underground economy. In fact, it has grown," said Rodriguez. "We have a problem and we cannot continue with the current system."

Rodriguez contends that the entire tax system has become complicated and must be revamped. One of the alternatives is the implementation of a sales tax system along with a flat tax income tax. The flat tax income tax would eliminate all the deduction process and the resulting loopholes that come with it.

"Where are we going with this? This can eventually bring a tax credit to those individuals making a certain amount of money per year," said Rodriguez. "They would receive a tax credit for the same amount."

Additionally, individuals could be eligible for an earned income tax credit, as these would be paying taxes on products that are not currently taxed, explained Rodriguez.

The study to be commissioned to the Society’s Foundation is absolutely necessary to really measure the impact and the extent of a sales tax on the island, as well as of a value added tax, said Rodriguez.

"The mayors of Ponce and Caguas, Rafael Cordero and William Miranda, respectively, have personally confirmed to me their interest in contributing financially for the realization of this study," said Rodriguez. "In fact, Cordero has already pledged $25,000 for the study."

The study could begin as early as November or December and take six to eight months for its completion, noted Rodriguez.

Chamber to support study

Puerto Rico Chamber of Commerce (PRCC) President Jose Joaquin Villamil said that his organization would seek to join forces with the Society of CPAs to contribute and make the sales tax study a reality.

"Our position is that the entire tax system needs a complete overhaul, and that overhaul must move us towards a tax system that is more consumer based, such as a sales tax or an added value tax," said Villamil. "We definitely support a sales tax system."

Villamil believes there’s a consensus large enough at all levels that thinks Puerto Rico must move towards that direction.

"This whole mess with the excise tax increases to cigarettes, sport utility vehicles, and alcoholic beverages, plus the issue with the air cargo carriers make the idea of a sales tax system easier to sell," said Villamil. "The sales tax absorbs most of the informal economy, is easier to administer, stimulates savings, and does not penalize productivity."

Selling it to politicians

"Politically speaking, the vast majority thinks erroneously that the implementation of a sales tax system in Puerto Rico would be detrimental to whomever promotes it," said Rodriguez. "They think it’s negative because now you don’t see or feel the excise taxes, but people will notice the sales tax right away. Instead of something negative, I see that as a positive."

Rodriguez believes that if the sales tax is combined with an income tax credit, it will be very positive for whoever implements it.

"The governor that is bold enough to do this will make, historically speaking, one of the most far reaching and important government decisions ever made," said Rodriguez. "It could turn a negative thing into a very positive one."

Rodriguez will be visiting and working with local Senators and State Representatives to help them understand that the sell is a positive one.

"If politicians market the idea well, it could become politically positive for them," said Rodriguez.

Cordero Badillo is not as confident as to whether the politicians will buy it.

"I’m pretty sure that if a legislative bill is presented, it will not pass because it’s a political issue," said Cordero Badillo. "Neither of the political parties in power will dare to implement such a tax. There is no political will."

As long as you have an import tax like the general excise tax in place, you are reinforcing the concept that Puerto Rico is an island. The moment you implement a sales tax, you are making the island look more like a state of the U.S., noted Luis Alvarez of Mendez & Co., adding that the Calderon Administration is avoiding the sales tax issue at all costs because they don’t want to implement a system in Puerto Rico that would bring the island closer to the U.S. tax structure.

"It’s a shame that because of political beliefs a good idea such as the sales tax is not evaluated on its own merits, but by its political impact and the perception it may have," said Alvarez.

House Speaker Carlos Viscarrondo has submitted a legislative proposal to study the implementation of a sales tax system in Puerto Rico. Senate President Antonio Fas Alzamora has said publicly that he would support such a study. Both legislative leaders were unavailable for further comment.

This Caribbean Business article appears courtesy of Casiano Communications.
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