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Commission proposes flat tax for Puerto Rico

The current governor of Puerto Rico, Anibal Acevedo Vilá, was elected in January of this year. Two weeks following his installation, the new governor established a Special Commission for Fiscal Reform (known by its Spanish acronym as CERF), giving it instructions to analyze Puerto Rico's present tax system and make to recommendations for reform.

Four months later, on April 30, CERF delivered its report to the governor, recommending a 10-10-10 comprehensive reform of Puerto Rico's tax system. The proposed system would work as follows:

A 10% flat tax on individuals.

This is a significant reduction from the current top marginal tax rate of 33% which, under certain conditions, can reach up to 38%. Single taxpayers with an average annual income of $15,000 would be exempt, as would married working couples having a combined annual income of $30,000. These levels would exempt 309,000 taxpayers from having to pay personal income tax, up from the 180,000 under current law. The majority of the newly-exempt would be taxpayers with an annual income below $20,000. Therefore, the 10% flat tax on individuals would eliminate taxation of poor persons.

CERF recommended that taxpayers be permitted to deduct mortgage-interest payments for their principle residence up to 30% of adjusted gross income. Additional deductions include contributions to retirement accounts, savings for dependents' education, and charitable donations. Taxpayers who have over $150,000 in reported income would only be able to deduct mortgage interest up to 20% of adjusted gross income, which adds an element of progression to the system. There would be no deduction permitted for social security and unemployment taxes (such as on mainland U.S.). Taxpayers who have an income of $100,000 or less would receive a tax credit of $500 per family member.

Individuals would pay 10% on dividends received from corporations, a small double tax after corporations pay 10% on business profits.

CERF estimates that the 10% flat tax would collect $1.25 billion, which is less then the $2.8 billion paid in personal income tax in 2004. Personal income tax would fall from 36% of total revenue to 12%.

A 10% flat tax on corporations.

Currently, only 35,000 of the nearly 140,000 registered corporations file tax returns. Local corporations are subject to a 39% tax rate, while companies operating under the Puerto Rico Industrial Incentive Act (PRIIA) pay between 0% to 7% in taxes. The uniform 10% rate is designed to refine the strategy of the PRIIA. Companies who pay the proposed 10% tax would be able to take it as a federal deduction when profits are repatriated back to the U.S. mainland. The corporate tax reform would double revenue from $2.4 billion to $5.7 billion.

Companies would receive tax credits for creating employment, infrastructure improvement, productivity, continuing employee education, environmental protection measures, and efficient energy use, which would reduce their effective tax burden.

A 10% tax on consumption.

This tax which, after five years, would be reduced to 9%, replaces a 6.6% general excise tax. The current excise tax cascades down from importer to wholesaler to retailer, and it results in higher prices for consumers. The 10% consumption tax would be a hybrid Value Added Tax (VAT) that could be implemented in a year. Exempted items would include prescription drugs, raw and intermediate manufacturing materials, educational products, and real estate services. Special excise taxes would remain on gasoline, alcoholic beverages, cars, and jewelry. To minimize the regressiveness of the consumption tax, there would be a "Social Fairness Fund" established to compensate families based on their income and spending capabilities.

It's projected that the 10% consumption tax would raise $3 billion, which would be added to the $1.2 billion raised in special excise taxes.

Altogether, CERF estimates that the reforms would result in tax revenue of $12.5 billion. After returning $2.5 billion in corporate tax credits and compensation to low-income and poor residents through the Social Fairness Fund, there would remain $10 billion which would be $2 billion more than the government collected in 2004. The additional revenue collected from upper-income households and corporations, would stem from closing loopholes, and through reducing evasion and avoidance.