Este informe no está disponible en español.


Consumer Spending Chokes

The $100 million in tax breaks this year failed to offset the $1.4 billion sucked out of the local economy by military spending cutbacks excise tax hikes, and job losses


June 10, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

The too-little, too-late middle-class tax relief

Cost-of-living increases, cutbacks in military spending, job losses, and higher consumer excise taxes threaten the consumer-led recovery of the local economy

Although the final tally isn’t in, the Puerto Rico Department of the Treasury (Hacienda) is expected to receive some 950,000 tax returns this year, or 15,000 more than last year. Hacienda’s goal for the 2003 tax year is to collect some $1.13 billion in income taxes, or $85 million more than for the previous tax year.

As of June 2, Hacienda had processed 939,990 tax returns, amounting to 23,728 more tax forms than last year. Some 500,401 taxpayers have received $351.9 million in tax refunds, a 54.8% increase over the same period last year.

What tax relief?

For the 2003 tax year, taxpayers benefited from eight new tax-relief measures approved by the Legislature, mainly targeting the middle class. Hacienda estimated taxpayers would receive $400 million in tax savings over the next four years as a result of the tax cuts.

But $100 million a year in middle-class tax relief is proving to be a drop in the bucket given the estimated $1.4 billion that has been sucked out of the local economy in the last year. When it comes to stimulating a consumer-led economic recovery, the tax cuts just aren’t cutting it.

The shutdown of the Roosevelt Roads and Sabana Seca naval bases, the departure of U.S. Army South, and the cutbacks at the Fort Buchanan Army base alone are estimated to have cost the economy of Puerto Rico close to $1.1 billion a year. Add to that the job losses throughout the economy that have cost another $200 million to $300 million a year.

In fact, the much-touted middle-class tax breaks haven’t even offset the tax increases shoved down consumers’ throats two years ago. Since June 2002, taxpayers have been paying $269 million a year in additional excise taxes on autos and tobacco & alcohol products.

Furthermore, despite the breaks in their returns for tax-year 2003, taxpayers have found as they begin receiving their highly anticipated tax refunds that they are being hit by rising inflation, fueled mainly by skyrocketing oil and gasoline prices, which has served to reduce their disposable income.

According to media reports, the average price of a gallon of gasoline in Puerto Rico is $1.95. A year ago, at the height of the war with Iraq, it was $1.47. That is a 32.6% price increase, and the price keeps climbing. Between this April and May alone, the price of gasoline jumped 10%.

To compound the trouble, this year there was a lot of confusion over the retention tables used to calculate how much tax is withheld from a person’s paycheck. In some cases less money was withheld than should have been, so taxpayers ended up paying more or getting a smaller refund than they had expected for the 2003 tax year.

And while many consumers on the island took advantage of historically low interest rates in the past few years to refinance their homes, the cash they got is largely gone already.

Bottom line, consumers remain cautious and aren’t spending on extra items, which could delay or thwart the much-anticipated consumer-led economic recovery.

In general, taxpayers fared well

"The general perception is that taxpayers came out ahead when they filed their tax returns this year," said Giovanna Patrono, H&R Block’s assistant district manager for Puerto Rico. "They didn’t necessarily receive bigger refunds, but they possibly paid fewer taxes."

Patrono said the working middle class benefited the most from this year’s tax breaks, especially married couples with children because they could claim the $3,000 deduction for married working couples filing jointly and the increased deduction for childcare.

Taxpayers also took advantage of the $500 deduction for the purchase of a computer for a dependent age 21 or younger. "Those taxpayers who bought a personal computer last year received an additional deduction. Any additional deduction is always welcome and helps the taxpayer," said Patrono. Savings from this year’s tax breaks could range from $1,000 to $2,000 per person, depending on the person’s tax bracket, added Patrono.

Eduardo Zayas, managing partner of accounting firm Zayas, Morazani & Co., said his taxpayer clients (mostly self-employed individuals) fared no better or worse in the 2003 tax year. That is because the tax breaks mainly targeted salaried joint filers with children, not the self-employed.

"The taxpayers I serve usually plan throughout the year how to take advantage of the tax breaks provided by the law," said Zayas. "All this effort is reflected at the end, when the taxpayer files his tax return. This year, taxpayers came out about the same as in other years."

For economist Vicente "Chenti" Feliciano, president of Advantage Business Consulting, the government’s decision to direct the tax breaks to the salaried middle class was refreshing and correct.

"The government did well to target the taxpayers who when they have money will usually spend it. It was a refreshing change from what we are used to in Puerto Rico, which is tax breaks for the upper-middle brackets, and it helps the consumer-led recovery," said Feliciano. "Besides, it is fair because the middle class deserves a break."

Effect of tax breaks watered down by rising inflation

"Any increase in consumer-goods prices will certainly diminish any tax benefit," said Victor Rodriguez, tax partner of accounting & consulting firm PricewaterhouseCoopers LLP.

Jerry De Cordova, a partner of accounting firm Aquino, De Cordova, Alfaro & Co. and head of its tax department, also believes any price increase on consumer goods will have an adverse effect on taxpayers’ wallets. "There have been increases in the cost of certain products, which could in some way minimize the savings obtained through the tax breaks," said De Cordova, who is also president of the Puerto Rico Society of Certified Public Accountants (CPAs).

Although she doesn’t consider herself an expert on economic matters, H&R Block’s Patrono said one doesn’t have to be a rocket scientist to figure out that the recent hike in oil prices has left a deep hole in everyone’s pocket. "Everyone has been affected by the oil-price increase, because it affects not only gasoline prices but also the price of all oil derivatives and all consumer goods that need to be transported," she said.

Adamina Soto, managing partner of accounting firm Kevane Soto Pasarell Grant Thornton LLP, believes that since locals have been contending with higher gas prices since early in the year, it will reduce the impact of this year’s tax benefits. Additionally, she said, the unusually high gas prices will force local families, who are so dependent on their vehicles, to adjust their budgets and their lifestyles.

"The average family budget is structured in such a way that there isn’t room for such high gasoline prices. Many families will have to adjust their budgets because with an increase in the price of gasoline, the price of everything else goes up, such as electricity, food, and clothing," said Soto. "People are already starting to talk about carpooling. If the price of gasoline keeps going up, it will be too much for many to bear."

Soto added that if oil and gasoline prices continue rising, taxpayers will forget about the tax benefits they received. "People usually remember what hurts their wallet the most. That is human nature," said Soto. "Since the last thing to hit them has been the increase in gasoline prices, that is what they are going to remember, not the tax breaks."

Feliciano believes that to some extent, the recent tax breaks have been negated by the price hikes. "Had there been no tax breaks at all for the middle class, however, the oil-price increase would have to be added on top of everything else," said Feliciano. "That segment of the population [the middle class] would be much worse off."

Feliciano said that although oil prices have gone through the roof, the latest oil-price increases will hurt the island much less than those in the past, thanks to long-term energy planning to reduce Puerto Rico’s dependence on oil. "The last time there was an oil shock, there was no EcoElectrica or AES [co-generators of electricity]. So, we are somewhat protected now from the oil-price increases, and electricity prices won’t be affected as much this time," he said.

Tax-withholding confusion

Some of the benefits of the tax breaks could have been reduced because the retention tables were never adjusted after the Calderon administration canceled the final phase of the tax reform proposed by Gov. Pedro Rossello. His administration had reduced the income-tax rates along with the tax-withholding rates.

"The Calderon administration eliminated Rossello’s income-tax-rate reductions, but the retention tables were never modified. So, taxpayers ended up with a lower tax withholding and had to pay more on their returns," said Teresita Fuentes, tax principal at accounting & consulting firm Ernst & Young.

Hacienda corrected the retention tables (and increased the withholding rates) late in 2003, but taxpayers only took notice when they received their W-2s earlier this year.

"Taxpayers received a smaller tax refund this year because tax withholding rates had been lower than they were supposed to be," said Fuentes, a member of the Puerto Rico Chamber of Commerce’s and the Society of CPAs’ committees on tax reform. "It could be that some taxpayers ended up paying a little more in taxes this year because of the lower withholding in 2003."

"The situation generated distrust and left a sour taste in everyone’s mouth, as it seemed Hacienda wanted to retain more money upfront from taxpayers, even though it had the intention to refund it in April," said Margaret Valentin, senior tax manager at PricewaterhouseCoopers. "As a consequence, taxpayers ended up with less disposable income."

PricewaterhouseCoopers’ Rodriguez added that if proportionately more taxpayers receive tax refunds for the 2004 tax year than in 2003, it would mean Hacienda is withholding more money than it should. "If, on the other hand, the number of taxpayers that receive tax refunds is stable, it means Hacienda is withholding the right amount," he said.

Marriage penalty still a penalty

Of the middle-class-targeted tax-relief measures in the 2003 tax season, the $3,000 deduction for married working couples filing jointly was one of the most significant because it helped to reduce the marriage penalty.

The penalty occurs when a married couple’s joint incomes puts them in a higher tax bracket than either spouse was when single. If a couple’s individual salaries are combined, their joint income in most cases will be subject to a maximum effective tax rate of 33%, said Rodriguez.

Eliminating the marriage penalty was part of the third and final phase of Rossello’s tax reform, which the Calderon administration canceled. Instead, said Ernst & Young’s Fuentes, the Calderon administration merely increased the deduction.

"Although significantly higher than the $300 deduction available before, the $3,000 deduction for married working couples filing jointly still doesn’t resolve the issue of the marriage penalty," said Fuentes. "The $3,000 deduction is a relief, not a solution. The solution is much more complex than simply granting a bigger deduction."

"The recent tax breaks were a relief for the working middle class, but the $3,000 deduction is no substitute for the elimination of the marriage penalty," agreed Soto of Kevane Soto Pasarell Grant Thornton. "To this day, many couples file separate returns because it still continues to be a heavy tax burden."

Rodriguez said the penalty is unfair to married couples who file jointly. "That a person who changes his or her civil status from single to married has an additional tax burden imposed upon him is seen as unjust, not only in Puerto Rico but in every other jurisdiction as well," he said.

The middle and upper-middle classes, added Rodriguez, are like the ham in the sandwich, meaning they are responsible for a large portion of the tax collections. "The middle class is still at a disadvantage when it comes to the marriage penalty. That has been recognized by many, including the political sector," he said.

Rodriguez said the Calderon administration might have retained the marriage penalty after realizing how eliminating it would hurt overall tax collections. Nevertheless, he said, the administration shouldn’t impose such an onerous tax burden on the middle class.

Taxpayers overtaxed

"If you ask any middle-class taxpayer, he will probably say he is still being taxed too much," said Rodriguez. "One must also consider that a taxpayer now has to pay between 15% and 40% in excise taxes when purchasing a vehicle, since one must have a car in Puerto Rico."

Puerto Rico has a 50-year-old system whereby a 6.6% excise tax (arbitrio) is imposed at the point of merchandise’s entry (i.e., the ports). In June 2002, the Calderon administration sent consumers and the local automotive industry into a tailspin when it implemented stiffer excise taxes on sport utility vehicles (SUVs), which include light trucks and minivans, and luxury cars.

The tax hike—part of the administration’s efforts to balance a $596 million budget shortfall—also applied to alcohol & tobacco products. Many consumers were forced to change their vehicle preference from SUVs to cars and their drinking and smoking habits by switching to less expensive brands.

Hacienda estimated the tax hike would generate an additional $269 million a year in taxes: $69 million from autos and $200 million from alcohol & tobacco products. During the first nine months of fiscal year 2004 (July 2003 to March 2004), Hacienda collected $733 million in excise taxes on these products, up 3.5% from the same period in fiscal 2003. These are additional taxes coming directly from taxpayers’ pockets.

Time for comprehensive tax reform

According to Soto, Puerto Rico’s tax system has received way too many patches (fixes) yet, the middle class still is carrying the bulk of the tax burden.

Experts agree that tax reform is necessary and that it should have three characteristics. First, there must be equality in the system. Second, income-tax brackets must be substantially reduced. Third, the 6.6% excise tax must be eliminated in favor of a sales tax, which is imposed at merchandise’s point of sale, or a value-added tax (VAT), which is imposed along the distribution chain.

"I don’t know if the politicians will be brave enough to discard a tax system and replace it with another during an election year. For the first time in many years, however, there is consensus that we must have comprehensive tax reform that includes the implementation of a sales tax," said Soto.

The excise tax system is considered inefficient because it has a high cascading effect. Consumers absorb the costs added as merchandise passes through the distribution chain, meaning they pay more than the Treasury Department collected on the merchandise and wind up with less disposable income than they should have.

Also, since the excise tax is collected at the point of entry, the system promotes tax evasion. With a sales tax or a VAT, however, tax evasion is minimized and the government collects more taxes. This, in turn, should allow the government to reduce all income-tax brackets.

"Tax reform is necessary. Finally, there’s consensus among all sectors that something has to be done about the excise taxes," said Ernst & Young’s Fuentes.

She noted that tax reform is usually implemented at the beginning of an administration’s term to give it enough time to establish regulations and make all the necessary adjustments.

"If we leave the tax reform until the end of an administration’s term, as is the case now, we risk completely nullifying its effectiveness," said Fuentes. "The Society of CPAs conducted its study and submitted its conclusions; Hacienda is about to complete theirs. Let us hope these don’t get lost in the process. We must take up the issue again when a new administration takes office in January of next year."

Changes for 2004 tax year

There has been an increase in the standard deduction for the 2004 tax year in Puerto Rico, returns for which should be filed by April 15, 2005.

A married person living with a spouse and filing jointly gets a $150 increase, from $3,000 to $3,150.

A head of household receives a $130 increase, from $2,600 to $2,730. A person filing as single or married not living with spouse gets $100 more, from $2,000 to $2,100. A married person living with a spouse but filing separately obtains an additional $75, from $1,500 to $1,575.

The general dependent exemption to which a taxpayer is entitled has increased from $1,300 to $1,600, the same amount currently available for dependents in college or studying in postsecondary professional-technical institutions.

The maximum earned income that a dependent in college may receive without being disqualified as a dependent for the calendar year in which the taxpayer’s tax year begins has increased by $100, from $3,300 to $3,400.

A tax credit for salaried people or pensioners with adjusted gross income over $10,000 but not exceeding $50,000 has been approved. The amount of the credit will vary, from $50 to $250, depending on the taxpayer’s income bracket and whether he files as single, head of household, or married living with spouse filing jointly.

To qualify for the tax credit, the taxpayer must meet all of the following conditions:

  • The taxpayer and his spouse’s income may be derived only from salaries and wages subject to withholding in Puerto Rico or from pensions or tips. The taxpayer may not receive any other income such as alimony, interest, dividends, self-employment, etc.;
  • The taxpayer isn’t required to file an estimated tax declaration under Puerto Rico Internal Revenue Code Section 1059;
  • The taxpayer is a U.S. citizen or a resident of Puerto Rico;
  • The taxpayer isn’t claiming a foreign tax credit or credit for income tax withheld at source for services rendered; and
  • The taxpayer isn’t claiming any other tax credit, except for this credit and the credit for contributions to the Free Selection of Schools Foundation.

Additionally, taxpayers age 60 or older will be able to claim a $130,000 exclusion on capital gains from the sale of their primary home, up from $110,000 in the 2003 tax year.

Consumers tend to spend less when personal income shrinks

According to economist Vicente Feliciano, local consumers are more confident and spend more when the economy is booming, thereby increasing their amount of debt. When there is uncertainty about the economy, however, they tend to worry more about debt and spend less.

"When things were going well, as it was in 1997, debt as a percentage of personal income went through the roof, hitting 50%, and then it started to go down in 1998," said Feliciano.

This phenomenon, he said, was partly the result of the refinancing boom, which put more money in the hands of consumers, and partly the result of income growing at a faster rate than total debt.

"Debt continued to grow; it is just that income grew faster. This allowed consumers to spearhead a recovery because they felt comfortable with the economic climate," said Feliciano. "In 2003, on the other hand, there was an increase in consumer debt as a percentage of disposable income."

That consumers jack up their level of debt when things are going well might seem contradictory, but Feliciano said this behavior has been consistent.

"When things are going well, people feel safe about their jobs and are more optimistic about their future, so they take on more debt. If people feel insecure about their jobs and uncertain about their future, they hold back on their spending," he said. Such was the case in 2001, he said.

By the time the economy begins picking up, consumers usually have cleared their balance sheets. "When things improve, consumers have less debt as a percentage of their disposable income and are able to take on more debt. This is what economists call a cross-cycle," said Feliciano. "When things are good, debt goes up. When things are bad, debt goes down."

Part of what is happening now is that consumer spending is being fueled by debt, because consumers are feeling a little more confident about their personal finances, said Feliciano.

In 2003, available personal income grew by 2.8%, practically unchanged from the 2.7% growth in 2002. Consumer debt, meanwhile, increased by 4.3% in 2003, up nearly three percentage points from the 1.5% growth in 2002.

Debt / Income Ratio 1993-2003

Consumer Debt*: 9,814 (1993) / 10,975 (1994) / 12,275 (1995) / 13,390 (1996) / 15,300 (1997) / 16,006 (1998) / 16,118 (1999) / 17,172 (2000) / 17,159 (2001) / 17,409 (2002) / 18,151 (2003)

Growth: -- (1993) /11.8% (1994) / 11.8% (1995) / 9.1% (1996) / 14.3% (1997) / 4.6% (1998) / 0.7% (1999) / 6.5% (2000) / -0.1% (2001) / 1.5% (2002) / 4.3% (2003)

Available Personal Income*: 23,195 (1993) / 24,248 (1994) / 25,591 (1995) / 27,976 (1996) / 30,607 (1997) / 32,066 (1998) / 34,042 (1999) / 36,239 (2000) / 38,405 (2001) / 39,438 (2002) / 40,537 (2003)

Growth: -- (1993) / 4.5% (1994) / 5.5% (1995) / 9.3% (1996) / 9.4% (1997) / 4.8% (1998) / 6.2% (1999) / 6.5% (2000) / 6.0% (2001) / 2.7% (2002) / 2.8% (2003)

Debt / Income Ratio: 42.3% (1993) / 45.3% (1994) / 48.0% (1995) / 47.9% (1996) / 60.0% (1997) / 49.95% (1998) / 47.3% (1999) / 47.4% (2000) / 44.7% (2001) / 44.1% (2002) / 44.8% (2003)

* In millions of dollars

Source: P.R. Planning Board

Rossello unveils his proposals for tax reform

During a miniconvention at Pichi’s Convention Center in Guayanilla June 5, the platform committee of New Progressive Party (NPP) gubernatorial candidate Pedro Rossello discussed the proposals that have been drafted so far, including those relating to tax reform.

Rossello’s proposals for tax reform include a 15-point strategy to improve the island’s investment climate, bolster the efficiency of the Treasury Department, control tax evasion and the underground economy, provide fair tax treatment to families, and promote education and savings.

The 15 Points Are As Follows:

  1. The tax credits awarded to several economic sectors will be reviewed and reformulated as direct incentives to the activity that wants to be promoted.
  2. Puerto Rico’s inclusion in the federal HubZone program will be encouraged.
  3. Incentives will be established to promote investment in technological infrastructure as well as research & development activities.
  4. The excise tax increases imposed by the Calderon administration on sport utility vehicles (including light trucks and minivans), cigarettes, and alcohol products will be eliminated.
  5. The excise tax will be replaced with a more efficient and balanced sales tax.
  6. The marriage penalty will be eliminated and the income-tax brackets reduced.
  7. A local earned-income credit will be established to benefit families with gross incomes of up to $15,000.
  8. Puerto Rico’s inclusion in the federal Earned Income Tax Credit program will be supported.
  9. Puerto Rico’s inclusion in the federal Supplemental Social Security Income program will be promoted.
  10. The deduction for contributions to an educational individual retirement account will be increased from $500 to $1,000.
  11. The deduction for a dependent’s education expenses will be increased.
  12. The deduction for contributions to nonprofit organizations will be increased from 33% to 50%.
  13. Filing an inheritance income-tax form and an application for exclusion when the only property involved is in Puerto Rico will no longer be required.
  14. Taxpayers will have access to the Treasury Department through the Internet so they can examine their statements online.
  15. Starting with the 2006 tax year, the tax exemption for pensioned taxpayers age 60 or older will be increased from $11,000 to $15,000 and for those under 60 from $8,000 to $11,000.

The proposals will be submitted for the NPP’s final approval during a general assembly June 27.

As for Popular Democratic Party gubernatorial candidate Anibal Acevedo Vila, spokeswoman Juanita Colombani told CARIBBEAN BUSINESS the resident commissioner is still working on his tax proposals, which will be made public and approved during the party’s general assembly June 27.

Electronic filing gaining ground with taxpayers

Although many locals are still wary about filing their income tax returns electronically (via the Internet), the number of people who chose this method for the 2003 tax year was more than double the previous year’s. The Puerto Rico Treasury Department (Hacienda) said it received some 16,000 electronic returns for the 2003 tax season, up 128.6% from last year’s 7,000.

One of the main benefits of filing online is that taxpayers receive their refunds through direct deposit in an average of two weeks. Taxpayers with questions during the electronic filing process can send an e-mail or make a phone call.

To print Hacienda’s forms, users must have Adobe Acrobat Reader Version 5.0 installed on their computers. Newer versions of the software won’t allow users to print the forms correctly. There is a link on Hacienda’s website,, to a free download of the software.

Once a taxpayer completes the electronic filing process, the system allows the user to print an electronic confirmation for the taxpayer’s records.

Administration issues of tax reform shouldn’t be neglected

The administration of a particular tax system may be the key to its success or failure. Yet, in the excitement of discussing tax reform, many diminish or entirely overlook the importance of the administration issues, said Teresita Fuentes, tax principal at Ernst & Young.

"A tax might seem efficient and simple in theory, but when you face the implementation and administration issues, it might be a different story. That is because at the end of the day, when the system doesn’t produce the revenue the government expects, you and I [as taxpayers] wind up footing the bill," said Fuentes.

Much has been said about the alternatives to Puerto Rico’s excise tax system. In Fuentes’ opinion, Puerto Rico has only two alternatives to its outdated excise tax system: a value-added tax (VAT) or a sales tax.

The choice, she said, must be decided on how the tax will affect revenue and how easy it will be to administer, not only for the government but also for the businesses that will need to comply with the tax. If Puerto Rico were to choose a VAT, she noted, it would have to look at other countries or possibly to the World Bank for guidance on the system’s administration.

Fuentes said amending the current system of excise taxes, as some tax experts have suggested, is no longer a viable option, especially after package-delivery company UPS claimed in court that the system interferes with its business and violates multiple federal laws.

Under the current system, an excise tax is levied upon entry of the merchandise at the seaport or airport. The amount of the tax varies, but the generally applicable rate on most consumer goods is 6.6%. There is a complex series of exclusions and exceptions, and the system promotes tax evasion.

"The Treasury Department shouldn’t rely for too long on the fact that taxpayers and withholding agents, such as overnight package-delivery carriers, are voluntarily complying with the payment of the excise tax," said Fuentes. "Furthermore, the excise tax system has been so badly eroded throughout the years that its capacity to generate more revenue is deficient, as has been seen in recent years despite multiple tax hikes, which only generate more revenue temporarily."

A sales tax

If Puerto Rico were to choose a sales tax, it would have the opportunity to adopt the uniform-sales-tax legislation being considered by most of the 50 U.S. states, said Fuentes. Called the Streamlined Sales Tax Project, the legislation is an effort by many state governments and the private sector to simplify the states’ tax laws and modernize their administration while assisting each other with cross-enforcement."

The system works by using the zip codes for each state to determine the sales tax applicable to each. Should you order something by mail, for example, the retailer would know, based on your zip code, the applicable tax rate and would be able to withhold and remit the tax to your state of residence," explained Fuentes. "Forty-two states and the District of Columbia are involved in this project."

The steering committee for the project includes not only the states’ revenue administrators but also the representatives of national retailers, manufacturers, trade associations, accounting firms, and other businesses, noted Fuentes. "If Puerto Rico joins the Streamlined Sales Tax Project, it will have not only some 50 partners to assist with taxation but also the advantage of a uniform law and administration system that doesn’t have to be reinvented," she said.


A VAT is a tax imposed on the added value of merchandise as it passes through the supply chain—from manufacturer to distributor, to wholesaler, to retailer, to consumer. Fuentes said she has heard people tout that some U.S. states already have or are turning to a VAT in lieu of a sales tax. According to her, however, that isn’t necessarily true.

In Michigan, for example, businesses are taxed under a Single Business Tax (SBT), implemented in 1975 to replace a corporate income tax and six other business taxes. This tax, which works like a VAT, has generated only 6% of all state revenue since its enactment and is to be phased out by 2010.

"Michigan Gov. Jennifer Granholm has said she wants to explore alternatives to the SBT and is participating in dialogues with business groups to come up with a plan, to be revealed this summer," said Fuentes. "The plan could include applying sales taxes to a broader array of services, but not a VAT."

Ohio recently proposed replacing the corporate franchise and tangible personal property taxes with a Business Activity Tax (BAT) instead of a VAT. The BAT would comprise a sales tax, a property tax, and a payroll tax at one rate of 0.71%, explained Fuentes.

"Louisiana eliminated its sales tax on food, residential utilities, and prescription drugs, while increasing the income tax rates of individuals in certain brackets. The state also proposed abolishing its business franchise tax and replacing it with a single business tax of 1.5%, but the state doesn’t have a VAT," said Fuentes.

A hybrid system

"Another option being considered by some [local] politicians is a hybrid system, where a VAT would be imposed on importers or distributors and a sales tax on consumers," said Fuentes. "This type of hybrid doesn’t consider issues such as the potential for double taxation, the complexities of administering two different systems, and the difficulties of transitioning from one system to two different systems applied at different levels."

Although the technical support available for this hybrid system hasn’t been disclosed, Fuentes said that according to discussions with other international consultants, it is possibly the worst choice in terms of administration. Another negative is that Puerto Rico probably wouldn’t be able to benefit from state tax regulators and revenue administrators from various countries who meet regularly to share their experiences with tax administration.

"It is an opportunity for the international community to structure exchange-of-information agreements and discuss treaties. Under a hybrid tax system, I am not sure we would be able to take much advantage of these experiences because they will all be different from our system," said Fuentes.

The verdict

"Leaving aside all political implications of this decision, which should never be biased by politics, and considering Puerto Rico’s similarity to the stateside economy and the number of business transactions occurring between businesses in Puerto Rico and on the U.S. mainland, it is only natural to recommend a sales tax over a VAT," said Fuentes.

She noted that after evaluating reports from two sources analyzing Puerto Rico’s situation, the State Society of Certified Public Accountants also recently recommended a sales tax instead of a VAT.

Of utmost importance in this debate, however, is that we focus on the administration issues to ensure we make the right decisions. "We need to keep government revenue healthy and businesses operating efficiently with minimal government intervention," said Fuentes. "For Puerto Rico to survive in the global market, we specifically need fewer government regulations."

Relief Measures for 2004

Tax Year At A Glance

  • An increase in the deduction for married working couples filing jointly, from $300 to $3,000.
  • An increase in the deduction for childcare, from $800 to $1,200 for one child and from $1,600 to $2,400 for two children or more.
  • An increase in the tax-deductible contribution to an individual retirement account, from $3,500 to $4,000 for a single taxpayer and from $7,000 to $8,000 for married couples.
  • A $500 deduction for the purchase of a personal computer for a dependent age 21 or younger.
  • Taxpayers age 60 or older can claim a $110,000 exclusion on capital gains from the sale of their primary home. This exclusion increases to $130,000 in tax-year 2004 and to $150,000 in tax-year 2005.
  • Local soldiers fighting in Iraq receive a 100% tax exemption for income received during active duty, plus a six-month extension on the deadline for filing their tax returns.
  • The tax rate for earned interest on bonds and other payments made by certain corporations and societies is reduced from 17% to 10%.
  • A 50% tax credit for donations to the Santa Catalina Palace patronage.

Source: Puerto Rico Treasury Department

Excise Taxes Collected on Alcohol & Tobacco Products and Automobiles

July-March, Fiscal Years 2003 & 2004

In millions of dollars

Product: FY 2003 / FY 2004 / % Change

Alcohol: 221.2 / 211.7 / -4.3

Tobacco: 109.7 / 106.5 / -2.9

Automobiles: 377.2 / 414.8 / +10.0

Total: 708.1 / 733.0 / +3.5

Source: Puerto Rico Treasury Department

This Caribbean Business article appears courtesy of Casiano Communications.
For further information, please contact:



Self-Determination Legislation | Puerto Rico Herald Home
Newsstand | Puerto Rico | U.S. Government | Archives
Search | Mailing List | Contact Us | Feedback