Would Puerto Rico Lose Tax Advantages with Statehood?

One of the tactics Puerto Rico has used to draw investors, businesses, and even wealthy residents is the tax break. Corporations that shelter their income in Puerto Rico, usually at little benefit to the Island, since the money is simply washed through small subdivisions that provide few jobs, may pay far less in taxes. Microsoft is a famous example; by setting up a tiny outfit in Puerto Rico with the headquarters in Bermuda, the software giant was able to pay just about 1% in taxes on their enormous income.

President Obama has proposed an end to the tax loophole that makes this possible.

This is not the first time that Puerto Rico has lost out on tax loopholes:

  • In 1984, the rum tax “cover-over,” an arrangement whereby Puerto Rico and the Virgin Islands receive grants from the excise taxes collected on the rum they produce, was capped at $10.50 per proof-gallon, but it has fluctuated unpredictably since then. The rum tax has been threatened many times, and could end at any time.
  • In 1986, Puerto Rico tried to negotiate a tax deal with Japan, but the U.S. refused to approve it, and the treaty didn’t happen. This was recently described as “a humiliation” by a former member of Puerto Rico’s government.
  • In 1996, manufacturing loopholes called Section 936 for the section of the IRS tax code in which they appeared began being phased out. The object of Section 936 was to encourage mainland companies to build factories on the island, but it was often used as a tax dodge, without bringing jobs or funds to the Island.

As long as Puerto Rico is a territory of the United States, any tax wiggles are subject to the decisions of the U.S. government. They can and will end any time the U.S. government says so. States have more rights than territories.

Puerto Rico does set tax rates for its residents, and both its income tax and sales tax levels are already among the highest in the U.S. and its territories. The Governor has recently added a gas tax that prevents the people of Puerto Rico from benefiting as other Americans have from falling gas prices, and has proposed a 16% VAT tax. Property taxes are also higher than those of most States.

Since these rates are set at the State level, Statehood might not change the tax burden on the residents of Puerto Rico. However, many more people would be eligible for the Earned Income Tax Credit, which sends a check each year to low income taxpayers on the mainland, so Federal taxes would benefit many of the people of Puerto Rico.

Puerto Rico has nothing to lose. The tax loopholes which benefit the few can be taken away at any time. The high personal tax rates might be adjusted when Puerto Rico is in a less desperate economic position.

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