Residents of Puerto Rico don’t pay federal income tax on income that they receive in Puerto Rico. They do pay payroll taxes, which support Medicare and Social Security, as well as tax on income sourced from the U.S. That came to $3.6 billion in 2016.
What about individuals in the states? According to a new estimate from the Tax Policy Center, 44% of Americans will pay no income tax in 2018. That’s about 2% more non-payers than in 2017.
The Tax Policy Center says that this is a feature, not a bug. “By design, the federal income tax always has excluded a significant fraction of households through a combination of personal exemptions, the standard deduction, zero bracket amounts, and more recently, tax credits,” they explain. The 2% increase this year is the result of increases in the standard deduction and the Child Tax Credit in the tax reform bill passed earlier this year.
Just as in Puerto Rico, most of the non-payers living in the States pay payroll taxes. However, people living in the States are eligible for refundable tax credits for which Puerto Rican taxpayers do not qualify.
Who are the non-payers?
About 60% of the non-payers pay taxes in the form of payroll taxes, just as the residents of Puerto Rico do. The other 40% of the non-payers are mostly retired people whose income is too small to be taxed.
In the States, refundable credits — credits which can provide a tax return refund if the credits take the filer’s income below $0 — can offset payroll taxes. The EITC and the Child Tax Credit allow about 9% to pay no income tax and to be paid back for their payroll tax.
Puerto Rico residents are not eligible for the EITC. They are eligible for the Child Tax Credit only when they have a third child. Residents of any State receive the Child Tax Credit as soon as they have one child. Therefore, the working poor in the States have a better tax deal than those in Puerto Rico.
How does Puerto Rico’s status affect the tax burden?
There is a bill currently under consideration in Congress, HR 6246, which will make Puerto Rico a State if it passes. At present, Puerto Rico is an unincorporated territory. With a poverty level twice as high as that of any State, Puerto Rico would probably continue to have a higher proportion of non-payers than the States, even if the Island is admitted as a State. In fact, the working poor in Puerto Rico could expect to get a refund when they are able to file income tax returns.
All 32 territories which have become States have been more prosperous as States than they were as territories. Assuming that Puerto Rico also becomes more prosperous as a State, the number of non-payers will decline. Puerto Rico would then pay more into the federal government as a State than as a territory.
The fact that Puerto Rico residents do not pay income tax is sometimes used as an excuse for the lower level of support received from the government. Since nearly half of all Americans pay no income tax, this argument may not reflect the complete picture.