Puerto Rico must wake up from its tax haven dreams
On October 5, the Organization for Economic Cooperation and Development (OECD) unveiled the consensus plan reached by the Group of 20 and more than 40 other countries regarding its base erosion and profit shifting (BEPS) project. BEPS refers to tax-dodging tactics by multinationals that erode a home country’s tax base by shifting profits to low tax jurisdictions.
The BEPS project is a frontal assault on tax havens of which Puerto Rico is a proud member. And although pride often cometh before the fall, in the particular case of Puerto Rico, the island has already been plummeting. In August, it began to default on part of its $72.2 billion headline debt, which does not include $43.4 billion in unfunded pension liabilities. Unemployment is at 11.6 percent, the worst in the U.S., and the economy has been contracting or flat-lining for nearly a decade.
Stunningly, Puerto Rico continues to cling to tax haven strategies as the central plank of its economic development strategy. It does so, not only in the face of the BEPS project but also as the U.S. government deliberates plans to tax offshore profits and find ways to prevent expatriation by U.S. multinationals.
Some of the fiscal tightening of the BEPS project may be achieved by U.S. regulatory changes. Others will require legislative action. But the trend is clear and it’s not Puerto Rico’s friend.
The U.S. territory’s long tradition of fiscal self-abandonment has undermined its ability to properly fund local government operations and maintain an attractive business environment. Taxing just 10 percent of GDP, Puerto Rico collects less than the 13 percent average of “very poor countries,” according to the July 11 edition of The Economist and is alarmingly behind the 34 percent tax collections of rich, developed jurisdictions.
In calling for “smaller government,” present and aspiring policy makers (as well as commentators and members of the U.S. media) seem oblivious to the fact that Puerto Rico’s government is giving away the store when it comes to the proper objects and levels of taxation. The taxes that are imposed are shamelessly regressive, now squeezing the poor and working class with an 11.5 percent sales tax, reportedly the highest in the U.S.
To be fair, the income of multinationals and well-heeled non-residents is not the only revenue base that virtually escapes taxation. Real property is another scandalous shelter for wealth, given the island’s absurdly low land and property taxes.
As old habits die hard, low taxes for nonresident investors have for decades been the calling card of Puerto Rico’s growth initiatives. Until 2006, federal tax breaks helped burnish this sacrosanct mantel by allowing vast profits to be booked in Puerto Rico and repatriated to the U.S. essentially tax free. The enormous subsidy footed by U.S. taxpayers was responsible for the creation of a manufacturing sector that was largely unmoored from the island’s true capabilities. Even while the subsidy — known as Section 936 of the Internal Revenue Code — was in place from the 1970s to 2006, the island consistently underperformed the U.S. mainland with high unemployment and low labor participation.
Now, even after the same request was previously turned down, Puerto Rico’s Fiscal and Economic Growth Plan published in September purports to seek passage of Section 933A, another federal tax subsidy seeking to turbo-charge its tax haven status.
Regrettably, the island’s self-destructive growth strategy evaded mention during the Senate Finance Committee hearing presided by Sen. Orrin Hatch (R-Utah) at the end of last month. The vital topic of growth was left mostly for last. And only one witness, Douglas Holtz-Eakin, former Congressional Budget Office director and chief economic advisor to Sen. John McCain (R-Ariz.) during his 2008 presidential election bid, was able to comment on this crucial subject. Holtz-Eakin’s remarks were essentially right: The island must restore growth by concentrating on its “inherent capabilities,” not federal aid.
But this seems to have fallen on deaf ears as the island continues to promote its tax incentives, not only in the face of disastrous results but also against the growing multilateral efforts aimed at snuffing out offshore tricks.
Puerto Rico must fundamentally change its fiscal policy. This means ditching its tax-exemption growth model. And in tandem, it must redirect its economy towards revenue-generating competitive activities, such as tourism and entertainment. With only 15,000 hotel rooms, this sector is grossly underdeveloped and need not rely on tax exemptions. (Just ask Hawaii which, in addition to local taxes, bears the full federal income tax burden that Puerto Rico does without). Crucially, the tourism and entertainment sector plays directly to the core strengths of the island’s climate, scenery and unfettered access to the U.S. Moreover, the sector has powerful synergies with the world-caliber talents of its people in the arts, music, entertainment and sports.
Puerto Rico’s tax haven strategy has been a wasteful dream, leaving its government broke and its economy in tatters. It’s time for the island to wake up and embrace a far more productive and self-sustaining reality.