At least two more members of the U.S. Senate committee responsible for tax laws are upset about Puerto Rico’s new laws that promise no or minimal Federal or territorial taxation to high-income individuals who move from the States or the District of Columbia.
One law, aimed at big, wealthy traders of stocks and bonds, enables new residents to avoid paying any tax at all on earnings from these securities bought while in Puerto Rico. It also provides that they owe a tax of five percent of the profits in the case of investments owned for 10 years and 10% on stocks and bonds owned less than 10 years. The earnings include interest and dividends while the securities are owned and profits from selling. In the States and DC, the individuals face a 23.8% of income Federal tax and State taxes on the income and on ‘capital gains’ from sales of the securities.
The other law lowers to four percent the tax rate on income from services provided in the States from the territory. Before moving, the individual would have had a 39.6% Federal income tax liability plus owe State income taxes in most States.
The Commonwealth government guarantees the local tax breaks until 2036.
The tax exemption and low rate are only available to people who have not lived in Puerto Rico for 15 years. Permanent residents of the territory and returning previous residents pay taxes on income up to a rate of 33% and owe 10% of profits from stocks and bonds.
Earlier this year, a spokesman for the U.S. Senate Finance Committee said that Chairman Max Baucus (D-Montana) was considering taking action in response to the new Commonwealth laws. He said that this would be done in a comprehensive reform of Federal tax law that Baucus and the chairman of the House of Representatives committee with jurisdiction over tax law hope to get enacted this Congress (which ends at the beginning of 2015).
Senate 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 DC or requiring the Commonwealth to agree to a closing of the loopholes that permit the new territorial laws.
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.
A former Chief of Staff of the Congress’ Joint House-Senate Taxation Committee, John Buckley, predicted that few members of Congress would oppose plugging the loopholes in current Federal tax law exploited by the new Puerto Rico laws, especially because the Federal budget deficit is now the primary issue in official Washington.
The Commonwealth’s Secretary of Economic Development and Commerce, Alberto Baco Bague, reacted defiantly to the statements, declaring that the territory would not change its law “under pressure from U.S. politicians.”
He also proceeded with an aggressive promotion campaign in the States, using the new laws to lure high-income individuals, particularly from the finance industry, to move to Puerto Rico.
The campaign recently prompted another senior member of the Finance Committee to strongly criticize the laws. And a fourth senior Finance Committee member judged that it would be difficult to gain support for assistance to the territory in light of the abusive laws.
Both of the two new critics have been backers of measures to help Puerto Rico in the past.
The Commonwealth’s campaign to convince constituents of U.S. senators to move to the territory to avoid Federal and State taxation has reportedly attracted more than a dozen multi-million dollar financial players so far this year. Talks are said to be underway with three dozen or so more.
The number includes about a dozen managers of hedge funds (funds that take big risks in investing monies of wealthy individuals).
Buckley noted that the laws are “the first time that Puerto Rico would … deliberately erode the U.S. tax base for individuals.”
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 Puerto Rico’s 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 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 a year ago.
Governor Alejandro Garcia Padilla and a majority of members of both houses of the territory’s legislature elected at the time of the plebiscite are ‘commonwealthers,’ however, and, having lost the plebiscite, dispute it. Because of this, President Obama has proposed another vote under Federal auspices and the U.S. House of Representatives Appropriations Committee has agreed.
Additionally, Puerto Rico’s representative to the Federal government who has a seat in the House with a vote only in committees and heads the territory’s statehood party, Pedro Pierluisi (D), and 125 other House members have sponsored a bill for a confirmation vote on statehood. If the vote reiterates the support for statehood, the bill provides for a transition of tax and program laws to enable Puerto Rico to be admitted into the U.S. as a State.
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 — one of the options suggested by Senator Grassley — with statehood and equates not taxing them with “commonwealth status.” The ‘commonwealther’ wrongly asserts that closing the 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.
