Under current Federal law, residents of Puerto Rico do not have to pay Federal income taxes on income from the territory, although they do have to pay the tax on income from the States and have to pay Federal payroll taxes.
Some who oppose treating the U.S. citizens of Puerto Rico equally with other Americans argue that Puerto Ricans would find that their income taxes would increase too much with Federal taxation of insular income. This is not the case.
In recent years, up to 49 percent of households in the States do not have a Federal income tax liability because their incomes are too law. For about 80%, that means that they earn less than $30,000 per year. There are others who are elderly and receive Social Security, plus a handful who earn more than $30,000 per year and are eligible for special income tax credits.
Additionally, many lower-income households are eligible for Federal income tax credits that exceed the amount they owe in income taxes — and, thus, receive a check from the Federal government for the difference.
These tax credits — which include the Earned Income Tax Credit and the Child Tax Credit — would apply fully in Puerto Rico if the territory became a State. At present, residents of Puerto Rico do not qualify for the EITC, and can qualify for the Child Tax Credit only if they have three or more children, although low- income workers in the States with one child or two children can also obtain the benefits.
These tax programs were established to make work pay better for low-income workers, enabling them to provide for basic needs for their families even though they earn little and providing a greater incentive for them to work than to obtain social welfare benefits. It also effectively subsidizes the wages that employers pay low-income workers.
The partial application of the refundable portion of the Child Tax Credit to Puerto Rico enables more than 150,000 low-income working families in the territory to live a better life. The more than $300 million a year is an important contribution to the territory’s failing economy.
In 2006, staff of the Congress’ Joint Committee on Taxation estimated that extending the Refundable Child Tax Credit to low-income workers in Puerto Rico with one child or two as in the States would provide another $180 million annually. The Committee staff also calculated that extending the refundable portion of the Earned Income Tax Credit would help low-income working families — and Puerto Rico’s economy — $520 million a year.
President Obama’s Task Force on Puerto Rico’s Status recommended that the Refundable Child Tax Credit be extended to low-income Puerto Rican workers with one child or two children.
Puerto Rico’s representative to the Federal government, who has a seat in the U.S. House of Representatives with a vote only in committee to which he is assigned, has proposed legislation for Child Tax Credit equality. Other Members of Congress have made the proposal in the past, including Hillary Clinton.
With an average household income of $27,017 and an average family size of 3.6, many Puerto Ricans would benefit from full participation in the income tax system. The Congress’ Government Accountability Office (GAO) has looked at the issue twice and is doing so again.
In 1996, GAO estimated that 59% of Puerto Rico taxpayers would receive more in refundable tax credits payable as cash from the Federal government than they would owe in Federal taxes. Only 41% would have had a net Federal income tax liability.
The study concluded that the percentage receiving a net benefit from the Federal income tax system could be greater as the benefits would encourage more people to file Federal income tax returns.
A 1998 GAO report calculated that an unspecified more than half of taxpayers in Puerto Rico would receive a net benefit from extension of Federal income taxes to the territory.
The GAO is completing another study that will cover the question. It is now expected to be released within the month.
If Puerto Rico becomes a State, Puerto Rico’s insular government should be able to substantially reduce its local tax rates for individuals. Currently, Puerto Rico has relatively high local tax rates because the territorial government is paying for services that the Federal government pays for in the States. Thus, even if some households would pay more in Federal taxes under equal treatment of the territory in the Federal income tax system, they would also pay less in State taxes than they currently do.