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Debate Over Sales Tax Continues As Election Looms

Economists, tax experts, and professional organizations reiterate advantages of sales tax over current excise tax and value-added tax


October 28, 2004
Copyright © 2004 CARIBBEAN BUSINESS. All Rights Reserved.

Last week, politicians from the two main political parties in Puerto Rico continued to squabble over the issue of implementing a sales tax to replace the current excise tax (arbitrios) system as part of a sweeping tax reform.

Two weeks ago, gubernatorial hopeful Anibal Acevedo Vila and his Popular Democratic Party reneged on implementing a sales tax, claiming it would impose an additional burden on the poor and the middle class. Acevedo Vila made the surprising announcement after consensus had previously been reached across party lines on the need for tax reform that includes replacing the excise tax with a consumer-based tax such as a sales tax or a value-added tax (VAT).

His opponent Pedro Rossello of the New Progressive Party has proposed replacing the 6.6% excise tax system with a sales tax as part of a sweeping tax reform that would increase the base of taxpayers and reduce income taxes.

The 6.6% excise tax is a broad-based tax on consumer goods that is imposed at points of entry into Puerto Rico (seaports, airports). It is included in the final price paid by consumers at the cash register, along with any markup added above the 6.6% as the product passes through the supply chain, from manufacturer to distributor to wholesaler to retailer to consumer. Puerto Rico is the only U.S. jurisdiction that taxes goods at the port of entry.

However, the multiplier effect of the 6.6% as it passes from hand to hand down the distribution chain ends up costing the consumer anywhere from 8% to 15%, causing prices of goods in Puerto Rico to be more expensive than in the U.S. This is known as the cascading effect.

One of the reasons businesses are in favor of a sales tax is that under the arbitrios system the importer has to pay the excise tax to the government up front in order to lift the merchandise from the port, but then is unable to recoup that money until it sells the merchandise to the next buyer in the distribution chain which sometimes takes months. As a result, many businesses have tens of thousands of dollars in excise taxes already paid tied up in inventory.

From the time the merchandise arrives in Puerto Rico until it is finally sold to the consumer a year can go by. Consequently, the cost of the 6.6% originally paid upon import, is multiplied by the use of money, the money tied up for a year and the handling and mark ups as it passes from importer to retailer.

With a sales tax, consumers pay the tax when they actually purchase the products at stores, online, or by mail, regardless of whether that consumer purchase is made one month after the merchandise arrived in Puerto Rico or a year or more later. In this way, no middleman in the distribution chain (importer/distributor, wholesalers or retailer) has to carry the burden of laying out the 6.6% excise tax paid to the government.

A VAT is imposed on the added value of merchandise as it passes through each stage of the supply chain.

The need for tax reform

As reported by CARIBBEAN BUSINESS last year (CB Dec. 11, 2003), one of the main reasons tax reform is being pushed is that under the current system it is impossible to collect taxes from the informal (underground) economy, unfairly increasing the burden on taxpayers, promoting tax evasion, and causing budget shortfalls.

Local economists, business leaders, government agencies, legislators and other politicians, and tax experts are firmly backing tax reform, as are professional organizations such as the Puerto Rico Chamber of Commerce, the United Retailers Association, the Chamber of the Food Marketing & Distribution Industry, the Puerto Rico Automobile Distributors Association, and the State Society of Certified Public Accountants (CPAs). These organizations all support a sales tax.

In favor of a sales tax

"The sales tax study prepared by the society’s foundation was in response to people’s complaints that the current tax system has incredible inequities, in which most of the tax burden falls on the working middle class," said Society of CPAs President Andres Morgado. "Based on that, the report reflects that the excise tax system must be replaced, and the Society is recommending a sales tax."

Morgado pointed out that the sales tax would replace the excise tax; it wouldn’t be a new tax or an additional tax, as some have claimed.

"Our study indicates that with the implementation of a sales tax, along with a reduction in the income tax rates, the government will collect more revenue than with the current consumption tax of arbitrios," he said. "This will be fairer to low-income individuals and to those who receive retirement or pension checks."

Morgado said the society’s study indicates the excise tax isn’t producing the expected results because its many sanctions and provisions make it difficult to administer.

"Because of the excise tax system’s cascading effect, the current arbitrios consumption tax can end up being as high as 18%, which the consumer pays, although the government collects only 6.6%," he said. "By collecting the tax at the end of the supply chain, as is the case with a sales tax, the consumer strictly pays the tax, which the government collects through the merchant."

Some still think there is no consumption tax in Puerto Rico today, but that’s because the excise tax is already included in the purchase price and people don’t see it, added Morgado.

"For years, we have supported the replacement of the excise tax with a sales tax because there’s a sector of the society that isn’t paying its share of taxes, the so-called underground economy," said Cirilo Tirado, chairman of the Puerto Rico Chamber of Commerce’s Legislative Affairs Committee. "With a sales tax, [all of] those who participate in this economy will pay, which will reduce costs across the board."

It is also believed that a sales tax will actually help the government curb tax evasion by some businesses that may be cheating in their tax returns. Since the sales tax is tied to actual sales, businesses will not be able to underreport their volume of business when they file their income tax at the end of the year.

A VAT would add costs to merchandise as it passes through the supply chain to its final sale, said Tirado. A sales tax, he added, would be much simpler to implement.

"A sales tax is much more effective for the government, and everybody contributes. It would definitely reduce costs, but everyone would have to play their social tax-responsibility part," said Tirado. "The good thing about having social tax responsibility is that everyone participates."

Economist Vicente Feliciano said a sales tax would be a major improvement over the arbitrios system. "The biggest impact of a sales tax on the middle class is that, combined with a reduction in income taxes, it would promote labor participation and savings and would capture more of the economic activity in the underground economy," he said. "The critical thing is, you can’t look at it as a stand-alone measure. It must be part of a larger tax reform."

A hybrid system?

It is rumored that stateside firm Bearing Point has recommended to the Puerto Rico Treasury Department (Hacienda) a hybrid system where a VAT would be imposed on importers or distributors and a sales tax on consumers. Teresita Fuentes, a tax principal at Ernst & Young and a former deputy secretary of Hacienda, said such a system would pose serious administration challenges.

"This type of tax system 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," said Fuentes. "It is possibly the worst choice in terms of administration."

This Caribbean Business article appears courtesy of Casiano Communications.
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