How the Puerto Rico Disaster Package Targets Relief but Creates Tax Complexity

In recent years, hurricanes devastated the U.S. Atlantic coast and other island territories. Many communities—including those in Puerto Rico and the Virgin Islands—are still recovering. This week, the House of Representatives plans to vote on a disaster aid package to expand taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. credits, provide subsidies, and increase funding contributions to taxpayers throughout the island territories.

To put this in context, the “Emergency Supplemental Appropriations for Disaster Relief and Puerto Rico Disaster Relief Act, 2020” (H.R. 5687) appropriates $4.67 billion in disaster aid funding plus $16 billion in tax relief provisions, according to the Joint Committee on Taxation (JCT) and Congressional Budget Office (CBO). This comes after a recent appropriations measure in December 2019 which allocated $8 billion for disaster relief.

Arguably, H.R. 5687 intends to provide needed financial relief to those impacted by unforeseen tropical storms. However, the mechanisms through which it seeks to accomplish these ends make the tax code more complex, unstable, opaque, and biased.

Among other provisions, H.R. 5687 would make six changes to various tax provisions for Puerto Rican, American Samoan, and other Caribbean taxpayers for certain expenses and services in the aftermath of the 2018-2019 hurricane seasons.

First, the measure would increase the Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (CTC) benefits for families with 1-2 children up to the current benefit levels available to families with 3 dependents in Puerto Rico. Specifically, Section 103 of the bill changes the number of dependents required for eligibility in the credit’s refundable portion, which, in current law, for taxpayers with 3 or more qualifying children, is the excess of any tax liability of Social Security taxes for the fiscal year divided by the total Earned Income Tax Credit (EITC). The upshot of this is to give smaller families in Puerto Rico the same benefit eligibility available to larger families.

Second, the bill reimburses Puerto Rico for expenses related to the creation and maintenance of an EITC system for the territory in calendar years 2021 through 2025. The same reimbursement requirement is applied to American Samoans and those residing in the Virgin Islands, but with a different funding structure.

Third, the bill increases the limit on the Low-Income Housing Tax Credit (LIHTC) claims by $50 million for 2020 in order to encourage developers to build in Puerto Rico in exchange for reduced tax liability. The current LIHTC limit is $8.96 billion for 2020.

Fourth, the bill raises the amount of the New Market Tax Credit (NMTC) companies can claim for investing in destroyed, underdeveloped, or low-income communities by $500 million for tax years 2020 and 2021. The NMTC equals 39 percent of the company’s original investment amount, which can be claimed over a period of seven years.

Fifth, the bill raises the amount of excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. revenue returned to Puerto Rico and the Virgin Islands. Currently, all excise tax revenues collected (under a specific cap) on rum products imported into the United States are returned to the Puerto Rican and Virgin Islands Treasuries, which then deposit these funds directly into specific distilleries in their respective territories. The cap limits the amount of excise revenues to a specific dollar amount per taxed proof gallon.

For many years, the cap stayed at its default rate of $10.50. However, in 2000, Congress raised the cap to $13.25, equal to the full excise tax levied on imported rum. Under current law, the cap would return to $10.50 in 2022. H.R. 5687 would effectively repeal the cap, further reimbursing the excise taxes paid by the Puerto Rican and Virgin Islands governments for imported spirits and reinvested in Caribbean distilleries.

Finally, the bill would reimburse Puerto Rico for paying employees—via an employee retention credit—who work in devastated disaster areas throughout the island. This is a similar provision to another disaster bill passed in September 2017 (P.L. 115-63).

As we’ve written before, the paradox of employing tax policy as an all-purpose tool is that the more targeted the relief that’s dispensed, the worse the tax system becomes overall, in terms of complexity and how much it distorts behavior in the marketplace. Though well-intentioned, targeted tax relief violates principles of sound tax policy and makes the tax system worse.

While the people of the island territories are in desperate need of logistical, financial, and economic support, a more complex tax code on a temporary basis will make the job of recovery and stability that much harder.

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