Treasury Secretary Francisco Parés Alicea. (GFR Media)

For the first time, and after three years of specific demands by the Oversight Board, through PROMESA, the Treasury Department published a report detailing how much it spends on the hundreds of tax credits, exemptions, deductions and preferential rates granted to individuals, companies and non-profit institutions throughout Puerto Rico.

This is the Tax Expenditure Report (IGT, Spanish acronym), a document that can be described as a snapshot - in dollars and cents - of the series of laws and tax reforms that both the New Progressive Party and the Popular Democratic Party have approved during the last five decades, at the request of economic, political and social sectors.

Although due to technical reasons figures should not be generalized, according to the document, in 2017, a year in which Hurricane María devastated the poorest and most indebted territory in the United States, the government granted through these special agreements, an amount similar to the entire consolidated budget that totaled about $25.5 billion back then.

Through four special tax regimes, such as the contribution to individuals and corporations, consumption tax and other taxes, $20.615 billion did not reach the Treasury during 2017, as a result of special measures.

In other words, under the premise that special tax treatments benefit the economy and improve the quality of people's lives, revenues totaling almost two and a half times the General Fund budget, about $9 billion, did not reach the Treasury.

In total, 80 percent of the special treatments granted in 2017 are related to the island's industrial sector, according to the IGT. That public investment would have made it possible for Puerto Rico's Gross Domestic Product (GDP) to reach about $101.13 billion by fiscal year 2018. Manufacturing represents, in essence, half of the island's GDP.

"For the Treasury Department, this (report) is a technical gem," said Treasury Secretary Francisco Parés Alicea, noting that the report was prepared by the Office of Economic and Financial Analysis (OAEF, Spanish acronym) and internal resources. U.S. Treasury Secretary´s advisor Geral Silverstein offered guidance and technical advice to OAEF officials.

"In the future, this report is going to become more sophisticated," added Parés Alicea, stressing that although the report details how much money is not reaching the government's coffers, the document does not issue an opinion about the effectiveness or adverse effects of current tax provisions.

According to Parés Alicea, the IGT - which is one of the financial disclosure requirements established in the fiscal plan - was handed over to the Board. The agency will release the document tomorrow (Monday, September 23).

In an interview with El Nuevo Día, both Parés Alicea and Economic Development and Commerce Secretary Manuel Laboy admitted that IGT 2017 data will create controversy, and they hope that, in the best of cases, will serve as a reference every time someone arrives at La Fortaleza or the Legislature to suggest or lobby in favor of a change in Puerto Rico's tax laws.

"It is important to know that this report does not evaluate the effectiveness of different types of policies or tax credits, it does not evaluate that, or the return on investment or social impact, but it allows those discussions to be complemented with data now," Laboy insisted.

The government's wallet

If the tax expenditure were to be compared to some daily living expenses, perhaps, it could be that of employees´ fortnightly pay and what, in the long run, ends up on their wallets.

A worker´s paycheck is subject to taxes and Social Security deductions as well as unemployment or maternity insurance, among others. Such deductions would be the closest thing to a piggy bank for retirement, a limited income while getting another job or financial support to families during the newborn's first weeks.

Tax expenditure is, therefore, the income that the government contributes to or invests in families, businesses or non-profit institutions. This, with the expectation that they can buy a house, create jobs or provide education or health services to the population, respectively. This contribution, subsidy or expense has the effect of reducing the statutory rate (that is, the rate established by law) or the taxes that taxpayers should pay to the Treasury, revenues used to provide services to the people.

The IGT comes to light at a time when the Board is preparing to file the central government's adjustment plan, a document that will establish the government's ability to pay bondholders and other creditors.

"This is an X-ray of a system that tends to choose winners. If you do this, you have a decree or if you consume this, you have this benefit," said Parés Alicea. He admitted the IGT shows what´s been around for years regarding tax matters: that Puerto Rico has used tax policies to "mitigate deficiencies" in other areas, either due to a lack of will or due to the limitations of its legal, political, and economic reality.

Thus, in 2017, in the Internal Revenue Code and tax incentives, there was - as the saying goes – a little bit of everything. In technical terms, that year, there were 302 deviations from the statutory rate for individuals and corporations on the island. According to the IGT, all sectors of Puerto Rico, to some extent and without exception, had a way to alleviate taxes.

These benefits are granted through four main groups:  exemptions, deductions, and credits taken by individuals, those received by corporations, and exemptions or reductions in rates for the purchase of goods in Puerto Rico and that are subject to the Sales and Use Tax (SUT) or other taxes.

Deduction of mortgage interest and student loans, exemption from Social Security taxes, pensions or lottery wins are among these special tax treatments. Preferential rates on export of services and for high-volume investors moving to Puerto Rico have recently made it to the headlines.

But the list of special treatments or tax incentives is so long and diverse that most people have no idea - until now - that the government promotes such activities. That would be the case of exemptions, credits or deductions for rental income in historic areas; the pay to priests, ministers, and designers;  overtime for police officers; buying local products or broadcasting TV programs produced on the island.

Also, there are special benefits for investing in areas like Río Piedras, Castañer or Santurce; employing young people; donations to charities; former governors' foundations or the Capitol board;  protecting the environment with recycling initiatives, as well as exemptions or preferential rates for medicine or food. There is even legislation that grants tax benefits to those who supply the fuel that the Puerto Rico Electric Power Authority (PREPA) uses to sell electricity, which is among the most expensive in the United States.

A special rate for doctors

"This report shows that we are an aging population," Parés Alicea said, pointing out that both Social Security income and pension exemptions top the list of special benefits to individuals. The government's tax expenditure on those provisions in 2017 was $124.9 million and $86.8 million, respectively.

Both figures are only preceded by two items: mortgage interest deduction, which was estimated at $201.3 million, and the special rate granted to doctors under Law 14-2017. That statute, the only tax expense on individuals directed at a particular professional class, was promoted by former Governor Ricardo Rosselló Nevares as a strategy to prevent the exodus of doctors, with a cost of, $126.6 million the very same year it was approved.

According to Laboy, although the IGT provides data on how much the government spends on the activities it promotes or encourages,  it should not be forgotten that tax decisions tend to influence the behavior of people and businesses, an element that is not contemplated in the IGT.

"The best example is that of doctors. Law 14 was approved when doctors and specialists were leaving the island. The government position and- was endorsed- was to give them a tax benefit because they were leaving Puerto Rico, which had an economic and social impact. We are not saying that (the preferential rate) is good or bad, what this report presents is how much that decision cost from the perspective of tax expenditure," Laboy said.

Manufacturing

However, these more than 300 exemptions, credits, deductions and preferential rates for individuals and companies pale in comparison to the benefits granted to the industrial sector through the 1998 and 2008 tax incentives laws, known as Acts 135 and 73. Only those two statutes represented about 60 percent of all tax spending in 2017, which is about $15.691 billion.

After that item, the most costly law for the Treasury from the tax point of view is Law 20-2012. The statute that grants a 4 percent rate to those who export services from Puerto Rico represented a tax expenditure of $111.3 million during 2017. Law 22-2012, which promotes the relocation of high-income people to the island, represented a $29 million expenditure.

"You have to put in perspective that there are limited tools to promote certain activities. We do not control monetary or international trade policy," Laboy said.

For Laboy, to promote economic activity, most countries and states use, in essence, the same tools:  encouraging new investment, promoting exports, monetary transfers - which, in the case of Puerto Rico, come from the federal government - and debt issuance.

"It's not just the United States, Ireland or Singapore, it's also Costa Rica, Panamá, economies that are actively competing to take what's being produced here," Laboy said.

Driven by a lack of other capabilities and the fact that Puerto Rico competes with the rest of the United States and the rest of the world, the island has clung to its tax structure to make economic activity viable.

In the case of the industrial sector, according to the head of the Department of Economic Development and Commerce, some 1,700 companies have decrees under Laws 135 and 73. Of this total, some 1,500 are local companies.

"What happens is that, because of their volume, non-local companies have the greatest weight, but here we have from those that produce limber and bread to those who produce enamels, plastics, bags, cartons, pastries and naturally, the pharmaceutical and biotechnology sector, receiving these benefits," Laboy said.

According to Laboy, while it could be argued that tax expenditure is high, the other side of the equation is how much the economic activity would be generated on the island without state investment and therefore, a lot less would reach the Treasury for other taxes such as consumption.

In the case of the industrial sector, Laboy said that tax expenditure brings the possibility to create 70,000 direct jobs, which together with indirect and induced jobs, represents a quarter of the labor force or 230,000 jobs with a payroll estimated at $6.9 billion.

SUT and taxes

As the IGT shows, the other two fiscal benefits are for the consumption and purchase of goods, two taxes -which because of their nature- were designed to counterbalance the island´s informal economy.

Although the IGT puts the debate on the convenience of this tax policy on the table, exempting food from the SUT cost the Treasury $882.1 million in 2017 (including about $80 million for post-María emergency measures). Exempting SUT on medicine cost another $439.5 million and SUT exemption for medical services and hospitals cost the Treasury another $715.6 million and colleges and universities saved another $287.3 million in that tax.

In total, SUT exemptions cost the Treasury $2.765 billion in 2017.

On the tax side, the biggest tax benefits granted by the state are tied to electricity generation.

Exemptions to the so-called "Bunker 6" fuel and natural gas, represented almost $60 million. Electricity generation with fuel or natural gas by PREPA or other entities is also exempted from taxes, which means state subsidies for almost $305 million.

Parés Alicea made it clear that tax expenditure can vary from year to year and that there could be years, such as 2017, in which extraordinary events such as a hurricane distort that analysis. As an example, Parés Alicea said that the tourism sector ended 2017 with losses due to the natural disaster. Also, that year they were able to increase deductions claimed by taxpayers for losses in their properties as a result of María.

What is indisputable, according to Parés Alicea, is that IGT 2017 is an important step in tax administration because Puerto Rico is finally adopting a standard of transparency that has been applied for decades in dozens of countries and in the future, the IGT will be released every year, a decision that should result in better economic and social policy decisions.


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