KPMG report would increase taxes by $2.5 billion a year
By : JOHN MARINO & ROSARIO FAJARDO
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Edition: February 12, 2015 | Volume: 43 | No: 5
Broad range of interest groups clamoring for exemptions
Stating its case that Puerto Rico’s current tax structures are “inordinately complex, due principally to a plethora of special provisions that for the most part were adopted in a haphazard manner over time,” KPMG, the consultants hired by La Fortaleza, have drawn up a sweeping tax reform that would increase government revenue by $2.5 billion annually through a broad-based 16% value-added tax (VAT).
However, sources indicated that the government must raise at least $1.5 billion in additional revenue a year—or $1 billion less than KPMG’s original proposal—to deal with its precarious fiscal situation. That figure will likely rise since last week a federal judge ruled the Puerto Rico Public Corporations Debt Compliance & Recovery Act unconstitutional, complicating matters further. The law outlines a bankruptcy-like procedure for most public corporations to restructure their debts.
Analysts told CARIBBEAN BUSINESS the decision would mean the commonwealth now needs a bigger financial cushion and will likely have to pay its obligations as they come due. With the Recovery Act in place, the commonwealth could negotiate with creditors because it could invoke the law as a “threat,” analysts said. That bargaining chip has now fallen by the wayside.
The VAT, or IVA by its Spanish acronym, is levied across the distribution chain and would replace the current 7% sales & use tax (IVU by its Spanish acronym).
The existing 7% IVU didn’t receive high marks from KPMG. “The existing consumption tax exempts numerous goods and services, the consequences of which are reduced revenue, complexity, increased administrative costs and tax-avoidance opportunities. Indeed the current compliance rate is estimated at 56%,” the KPMG report states, calling this “an obviously unacceptable number.”
Instead, KPMG’s proposal calls for a broad-based 16% VAT, providing regressivity relief for the poor and working poor. The plan would eliminate most of the existing consumption-tax exemptions, with the 16% tax placed on unprepared food and medicine, providing exemptions only on exported goods and services, financial services, residential housing, water and electricity, fuel, and hotel services.
As CARIBBEAN BUSINESS went to press, officials were reportedly fine-tuning the list of exemptions, as many special interest groups, including those representing hospitals, pharmacies, restaurants, farmers and developers, have made their way to La Fortaleza, clamoring that their goods and services be exempt. It is widely believed that unprepared food and prescription drugs will be exempt from the proposed VAT.
The proposed reform would increase taxes for all taxpayers except those earning less than $21,800 annually, who would pay no additional tax, according to the KPMG report.
Taxpayers earning $21,800 to $33,000 would pay an additional $508 a year, while those earning $33,050 to $84,170 would get hit with a tax hike of between $1,761 and $1,836, the report indicates. Taxpayers earning more than $84,170 annually would be subject to a $4,548 tax hike.
The reform would also eliminate most income-tax exemptions, including the Act 22 tax break for wealthy investors who move here. The mortgage-interest deduction would be converted to a tax credit that phases out as a homeowner’s income increases.
In addition, the plan would subject Social Security earnings in Puerto Rico to taxes for the first time.
Since the VAT is a regressive tax, placing a higher burden on the poor, regressivity relief would be provided. Low-income residents would be spared the pain of the 16% tax through direct cash payments to totally eliminate the tax burden on food, medicine, education and clothing, which would total $1.42 billion annually. Government officials are contemplating possible refunds of up to $2,000 a year on VAT payments for people on the lowest rungs of the income ladder.
Individual income taxes would be cut by 28.8%, with those earning $35,000 or less and married couples earning $70,000 or less completely exempt from taxes, and those earning more than that being subject to either 15%, 20% or 30% rates, depending on income.
Meanwhile, corporate taxes would be slashed by 30.6%, with most of the relief coming through the elimination of the gross receipts tax, locally known as the patente nacional. Under the reform, businesses would be subject to a fl at 30% corporate rate.
Officials have pledged to introduce tax-reform legislation by Feb. 15.
KPMG officials said the implementation of the new system usually takes 18 months to two years.
“The objectives of tax reform are to ensure adequate revenues to the commonwealth and promote economic growth by broadening the tax base, assuring an equitable distribution of the tax burden and enhancing compliance,” the KPMG report states.
La Fortaleza spent $4.7 million on the tax reform report.