Trending

Newsletter

16 Percent VAT Is Economic Suicide for Puerto Rico

By: Frank Worley-Lopez - Apr 7, 2015, 7:37 am

Español It’s easy to criticize: find something you don’t like and pick on it. It’s harder to offer thoughtful, practical alternatives. Today, I’ll do both.

The government of Puerto Rico is about to enact a staggering 16 percent value-added tax, or VAT (IVA by its Spanish acronym). It’s purpose is to raise the money needed to keep Puerto Rico from insolvency. This is sheer madness.

The government of Alejandro García Padilla is driving ahead with a 17 percent VAT rate. (Flickr)
The government of Alejandro García Padilla is driving ahead with a 16 percent VAT rate. (Flickr)

Sixteen percent VAT is the same as having 16 percent inflation in the first year, with the potential for greater cost increase in years to come. VAT is often called a hidden tax because instead of a sales tax, which is added after the purchase, the VAT is already included in the price.

The problem is that VAT can be rolled over from an importer, to a distributor, to a retail outlet, meaning it can easily morph into a 16 percent charge, plus an additional 16 percent on the new price, and then another 16 percent surcharge on the consumer price.

The current administration has taken a tough line on requiring business to business (B2B) taxes and the new VAT will be imposed on them as well.

The average consumer in Puerto Rico will see the value of their paycheck drop by no less than 16 percent when it comes to consumer goods and many services. Reports in late March indicated that even new hospital and medical services could suffer due to the VAT increase.

Somehow, the administration of Governor Alejandro Garcia Padilla thinks this will raise enough revenue to service Puerto Rico’s current debt, which is somewhere north of US$73 billion. He also claims the new tax, which would replace the current sales tax, will be good for the Puerto Rican economy.

Not everyone is drinking the Kool-Aid.

Spending Problem

My prediction is that if this is enacted it will be the final nail in the coffin for Puerto Rico’s economy. Sales and economic activity will drop sharply in the first year, leading to more business closures, greater unemployment, and even less economic activity. All of that means less tax revenue, not more.

Puerto Rico will end up in an even worse situation. So what’s the alternative?

Puerto Rico doesn’t have a revenue problem. It has a spending problem. The key to balancing the budget and bringing debt under control is to stop spending as much: plain and simple. Whatever margin of the annual budget is being spent on debt servicing is the base amount in determining how much to cut.

My estimate is that Puerto Rico is spending between 25 and 30 percent on servicing its debts. However, this may actually be much higher, since the island continues to borrow more money ever year, even taking out loans on multiple occasions annually.

Puerto Rico needs to eliminate the debt servicing and eliminate the debt itself. In order to do so, it has to face up to another billion dollars in cuts (or about 10 percent of the budget) and dedicate it to paying down the debt.

But here’s the scary thing. If the island pays its interest and one billion dollars in debt each year, it will take 73 years to pay off the debt. Government wouldn’t be able to grow by any significant amount for decades.

So cutting back on government spending is only part of the solution. Next up is streamlining the tax code to make it easier for people and business to pay their taxes and reduce avoidance rates.

Greater Efficiency

To do this I recommend a no-deductions flat tax percentage on payroll income, a sales tax (at point of sale only, not B2B) and a flat tax for corporate and business profits, including for the self employed. Income, sales, and profit taxes should be fixed at the same percentage for all three, and all other taxes and regulations should be repealed.

This simplifies the process, lowers costs for business, and would help the economy move forward. The elimination of the confusing (if not self-defeating) tax code will make a lot of people happy, as there would be no more filing individual tax returns with the Hacienda, Puerto Rico’s tax office.

Taking ship for foreign shores may be the only way to escape Puerto Rico's economic decline. (Wikimedia)
Taking ship for foreign shores may be the only way to escape Puerto Rico’s economic decline. (Wikimedia)

The final and hardest part of this suggestion will be reforming labor laws and public sector unions. I recommend ending union membership requirements in both the public and private sectors.

This wouldn’t prohibit unions from forming, nor would it interfere with their right to negotiate a contract for union members. It only means that those who don’t want to be in the union don’t have to be, and they can continue to work while the union is on strike.

All current workers’ rights laws must be reviewed, and many updated and or repealed: workers rights are meaningless if workers don’t have jobs, after all. In my view, labor protection laws have driven up the cost of doing business in Puerto Rico to such an extent that foreign investors are turning away in droves.

Those are my recommendations to avoid Puerto Rico’s disastrous VAT tax maneuver. However, if Padilla’s administration goes ahead and implements it, there is one other option: jumping on a yola and immigrating to the Dominican Republic. At least the cost of living will be cheaper.

Edited by Laurie Blair.