Governor Alejandro Garcia Padilla (“Commonwealth” party) last week proposed substantial income tax increases for most Puerto Ricans days after he continued to promote exemptions from the same taxes to encourage residents of the States to establish residence in the territory.
His budget for the fiscal year that begins July 1st would: increase the tax rate on investment income by a half; end the credit against taxes that low-income individuals can take for income from work; and cut the tax credit for people 65 years of age and older in half.
Garcia Padilla’s primary strategy for pulling Puerto Rico’s economy out of the tailspin that it has been in for eight years after growing more slowly than the States for three decades before is offering people who establish residence in the territory no taxation of income from investments and a tax rate of only four percent on income earned from providing services in the States, both until the year 2036.
The offer is particularly attractive because, under current Federal law, establishing residence in Puerto Rico also enables the individuals to avoid any Federal taxation of the income (as well as further State taxation). The combination means that the individuals have no tax liability to any government on investment income and only have to pay taxes at the rate of four percent of income from continuing to provide services in the States.
Puerto Ricans, however, face –
– An increase in the tax on ‘capital gains’ — profits from the sale of investments –from 10 to 15 percent of the profits and a reduction in the amount of capital losses that they can take against capital gains,
– An increase in the tax on income from business dividends from 10 to 15 percent,
– A similar increase in the tax on interest from bank deposits and government and corporate bonds,
– Elimination of the $450 Earned Income Tax Credit against taxes due on income from work in the case of low-income workers — which would deny them an estimated $124 million in Fiscal Year 2015, and
– A reduction in the tax credit that individuals 65 and older can take from $400 to $200, which would cost them an estimated $100 million next fiscal year.
Individuals from the States who establish residence in Puerto Rico, however, would pay no tax on capital gains or on dividend and interest income and only the four percent tax rate on income earned from services provided in the States from Puerto Rico.
The tax exemptions for individuals from the States who establish residence in Puerto Rico are especially attractive for people in the financial industry, including large-scale investors in stocks and bonds and investment managers.
Just days before the Governor’s proposed budget was released, the Garcia Padilla Administration co-sponsored a major promotional event on the tax exemptions for individuals from the States who establish residence in Puerto Rico.
Commonwealth government officials say that hundreds of big, wealthy traders of stocks and bonds have signed up to take advantage of the tax exemptions, including several billionaires. Before establishing residence in Puerto Rico they would owe Federal income taxes up to 23.8% on capital gains, dividends, and interest and up to 39.6% on earned income plus State taxes in most States.
Last year, a spokesman for the U.S. Senate Finance Committee said that then Chairman Max Baucus (D-Montana) was considering taking action in response to the new Commonwealth tax exemption laws. Committee Ranking Minority Member Charles Grassley (R-Iowa) explained that the action could include taxing residents of Puerto Rico equally with residents of the States and the District of Columbia or requiring the Commonwealth to agree to a closing of the loopholes that enable people moving from the States to the territory to avoid any or almost any taxation of the income.
Committee Member Charles Schumer (D-NY), whose State is losing taxpayers to Puerto Rico, complained to Garcia Padilla in public about the tax exemptions and the Governor’s administration’s aggressive promotion of the exemptions to lure people away from the States.
Under current Federal law, residents of Puerto Rico are liable for Federal taxes on income from the States but not on income from the territory. Interest, dividends, and capital gains from stocks and bonds are taxed based on residence, so no Federal tax is due on that income.
Garcia’s Secretary of Economic Development and Commerce, Alberto Baco Bague, reacted defiantly to the congressional statements, declaring that the territory would not change its law “under pressure from U.S. politicians.”
Puerto Rico has previously sought and used tax breaks to encourage companies to manufacture in the territory rather than in the States.
A major Federal tax credit enacted to encourage companies in the States to make job-creating investments in Puerto Rico wound up benefitting businesses far more than the territory’s economy. It was repealed in 1996, fully ending as of 2006, in large part because members of Congress considered it unfair to companies in the States.
Puerto Rico tax avoidance measures are possible because of territory status, which is often misleadingly referred to as “Commonwealth” after a word in the formal name of the territory’s local government.
The U.S. Constitution requires that Federal taxes be the same throughout the United States. Puerto Rico, however, is a possession rather than a part of the U.S., although it is treated like a State under most laws — with tax laws being a major area of exception along with some programs for the needy and to ensure health care.
Whether Puerto Rico will eventually become a full, permanent part of the U.S. — a State — or become a nation has not been determined. Puerto Ricans voted against the current, temporary, unincorporated territory status and for statehood in a plebiscite under local law held along with the November 2012 elections. The Federal government enacted a law in January providing for a plebiscite under Federal law because Garcia and his “Commonwealth” party refuses to accept the results of the 2012 plebiscite.
Economic and Development Secretary Baco equates ensuring that big sellers of securities who move to Puerto Rico pay taxes equally with big sellers in the States with statehood and equates not taxing them with “Commonwealth status.” The ‘commonwealther’ has erroneously asserted that closing the current tax avoidance loophole “would change Puerto Rico’s status” and contends that a closing is unlikely “because statehood is unlikely.”
Some members of Puerto Rico’s “Commonwealth status” party also wrongly contend that the Federal government cannot tax in Puerto Rico. According to the U.S. Supreme Court, however, Congress can govern Puerto Rico except to the extent that the fundamental rights of individuals (such as freedom of speech) would be limited. In any case, Federal laws are supreme, applying irrespective of local law, and Congress has amended tax laws that are part of the current governing arrangement for Puerto Rico.