Puerto Rico Introduces a VAT; Is the U.S. Next?

Update: The tax reform bill has been voted down with a vote of 22-28 on April 30th when it was brought to the floor. Six members of the majority party voting against it as well as all of the minority delegation.

Puerto Rico introduced a bill in the Commonwealth’s House of Representatives yesterday to implement a Value Added Tax (VAT) while eliminating or reducing several other taxes. Given the economic and political integration between Puerto Rico and the United States, the bill could provides a test case for the viability of a VAT in the United States.

After almost a decade of negative average growth, representatives hope to stimulate the Puerto Rican economy through tax reform. They call for the removal of the Patente Nacional, a gross receipts tax, which is particularly damaging to economic activity. The exemption for personal income tax is slated to increase to US$40,000 for individuals, reducing the effective personal tax rate to around 21%. Corporation receive a lower tax of 25% as well.

To make up for the lost tax revenue, a 16% VAT is introduced in two stages. In the first stage, starting April 1^st, the current sales and use tax system (SUT) is increased from 7% to 16%, and a mechanism for reporting along the value chain is implemented. In the second stage, starting December 31^st, the SUT is eliminated, and the 16% VAT is fully implemented with a long list of exempt goods and services.

In addition to the VAT, capital gains and dividends tax rates are increased to 30%, eliminating their special treatment.

Several other exemptions are eliminated as well. The tax exemption on the sale of a primary residence is eliminated. The mortgage interest deduction is spared, but essential reduced by half.

Although it seems likely that the bill will pass, the Puerto Rican government still has the task of educating the public on the new taxes. The Treasury Secretary, Juan Zaragoza, has even launched a website explaining the new provisions.

The list of changes to Puerto Rico’s tax code seems like a laundry list of desired reforms to the U.S. tax code. As such, Puerto Rico has just become a laboratory for future U.S. tax reform. U.S. Policymakers are likely to keep a close watch on the experiences of Puerto Rico as they search for ways to improve the U.S. economy.