Despite moderate financial growth reported in the several facets of Puerto Rico’s economy and a positive outlook echoed among the public sector, the island faces a series of challenges that point to a grim scenario in the near future.
One of the main concerns shared among several economists is the eventual elimination of Act 154 of 2010, the Foreign Corporations and Partnerships Tax, which allows foreign corporations that operate on the island to claim a 100 percent credit on monies paid to the local government. Under this law, foreign companies pay a 4 percent tax on their transactions between the parent company and its local affiliates.
Since the act’s implementation, this tax has represented at least 20 percent of the General Fund’s budget, amassing about $1.8 billion annually in contributions that are, in turn, disbursed for government payroll, the University of Puerto Rico, the Department of Health and other key agencies.
Although Act 154 was initially designed as a temporary benchmark to be eliminated by 2016, different administrations have modified it in order to keep the tax at 4 percent. However, the U.S. Department of Treasury recently announced that the local government needs to start taking the appropriate measures to eliminate this law—an issue that economic consultancy firm Inteligencia Económica labeled “a monumental task.”
Gustavo Vélez, president of Inteligencia Económica, affirmed that without that tax revenue, “we believe that the government would face serious pressures for liquidity, which could, in turn, force reductions in public spending, including essential services and payroll.”
Heriberto Martínez, president of the Puerto Rico Economists Association (AEPR by its Spanish initials) told THE WEEKLY JOURNAL that there is no “real applicable tax” that could be implemented to generate the same revenue as that collected under Act 154, and concurred that its eventual elimination will lead to reduced allocations to government agencies that offer essential services.
Thus, the economist warned that the government would most likely increase the Sales and Use Tax (IVU by its Spanish acronym), which currently stands at a whopping 11.5 percent, the highest in any U.S. jurisdiction.
“Each point from the IVU is roughly $220 million to $230 million, so with a 2 or 3 percent hike to the IVU, there is the expectation that we could collect between $670 million and $700 million… What that does, at the end of the day, is further pressure the economic agents in Puerto Rico who already pay a lot in taxes… which could contribute to emigration,” he warned.
He emphasized that this would result in “the worst of all possible worlds” with under-financed government instrumentalities and a lower population.
In this regard, Alba Brugueras—economist and professor at the Sacred Heart University in San Juan—said that a higher IVU is within the realm of possibilities, but she believes that the government would most likely introduce other proposals for the island’s tax system.
She stated that perhaps the public sphere will reconsider establishing a value-added tax (IVA by its Spanish acronym), which garnered a heated debate in 2016. Brugueras observed that the conversation didn’t have a final conclusion, adding that this particular tax has been successful in other countries.
“The studies are there, as are examples from many countries that follow this tax system… I think that [the conversation] could take off at any given time, but I believe that [it will] in a more relaxed discussion and in a discussion with different economic sectors on the island,” Brugueras said.
In any case, the elimination of Act 154 threatens to hinder Puerto Rico’s economic development and quality of life, as well as taxpayers’ pockets.
“The new payment sources generated on the island must be based on new forms of business, on new investment sources and we must be creative in that regard. There will be negotiations with the federal government to see what relief or what assistance can be created so that the impact is not too big,” Brugueras asserted.
Stalling in Debt Restructuring Agreements
Because the 4 percent collected under Act 154 represents a sizable portion of the government’s budget, its elimination could also dismantle any progress relating to the debt restructuring agreements of multiple agencies, such as the Puerto Rico Industrial Development Co. (Pridco), the Aqueduct and Sewer Authority (Prasa), the Electric Power Authority (Prepa), and the Sales Tax Financing Corporation (Cofina by its Spanish acronym).
Brugueras explained that the estimates considered in debt restructuring agreements were inflated because their respective adjustment plans were counting on the revenue from Act 154. “This will definitely affect any future agreement,” she stated.
Moreover, its impact would also be reflected in the Plan of Adjustment proposed by the Financial Oversight and Management Board (FOMB) as a means to exit bankruptcy and restore access to capital markets.
Underwhelming Progress in Opportunity Zones
Ever since the government incorporated the Opportunity Zones (OZ) program into the Puerto Rico Incentives Code in 2019, a big chunk of the discussion surrounding economic development has centered on attracting local and foreign investment through its tax incentives. However, the government has not yet attracted significant investment through this measure, seemingly stemming from a lack of knowledge regarding this incentive, even among elected officials.
As reported by THE WEEKLY JOURNAL, the government released a list of eligible commercial activities under the OZ program and announced that a second list will feature specific activities with further incentives by region, but the central government is presently waiting for mayors to outline which economic sectors they want to endorse in their respective municipalities.
When asked to evaluate the OZ program’s implementation, Martínez labeled it as “deficient and harmful to the general economy.” He added, “there is no transparency, there is no diligence and there is not a single person whom I know to have economic planning expertise to ask where the OZ are headed.”
Brugueras stressed that the government must carefully assess which economic activities are suitable to the island’s priorities and to the potential of each municipality or region. She listed tourism, agriculture, innovation technology, infrastructure and manufacturing as some of the sectors with the most opportunities, but warned that any ventures must be tied to strategic planning.
Meanwhile, Martínez scrutinized the present administration for reportedly lacking a team of economists to assist in developing an economic public policy to address claims by residents and corporations.
“That is the challenge that we have in the country, with the exception that we’ll have elections in November. The expectation that I have as president of the AEPR is for economic plans to be done seriously and to allow the Association to evaluate it with economists from all [political inclinations],” he said.
Emigration a Shared Concern
Another issue that poses a hindrance to the island’s economic development is the emigration trend that has seen the exodus of 600,000 people between 2010 and 2017, Vélez commented. The economist explained that, during that time, Puerto Rico lost 18 percent of its population, with an average of 1.7 percent fewer residents every year since 2010.
Recent data collected by the U.S. Census Bureau indicates that the population grew by 0.01 percent in Fiscal Year 2018-2019, but economists agree that the emigration trend largely surpasses immigration, even considering the residents who are returning to the island after a temporary absence caused by Hurricane Maria in Sept. 2017.
Vélez and Martínez affirmed that the slight increase reported in the last fiscal year was prompted by federal recovery funds but they warned that if the population were to perceive stagnancy in this regard, emigration would return to pre-Maria numbers, which would result in more local economic struggles.
“As long as we are in this parenthesis of positive economic impact due to additional federal funds… we will see that positive macroeconomic data and demographically as well. […] What will happen if those additional federal funds stop arriving in Puerto Rico? Simple answer, we will return to the trends of population loss and wealth loss that we had until 2017,” Martínez said.
U.S. Issues’ Impact on the Island
Given that Puerto Rico is a U.S. jurisdiction, issues affecting the mainland reflect on the local economy, sometimes at a larger scale. This year kicked off with flaring tensions between the U.S. and Iran, causing a wave of uncertainty that has stirred political and financial discussions worldwide.
Regarding this particular conflict, Martínez noted that certain investment areas could make a profit but Puerto Rico is largely excluded from potential growth opportunities.
“In countries that do not export petroleum, as is Puerto Rico’s case, this has a negative impact because it will be reflected on Prepa and it will be reflected in gas prices, which for many families in Puerto Rico who are already drowning because of the economic situation… will be very difficult, more so in an island where we don’t have effective public transportation,” the AEPR president said.
Apart from military conflicts, both Brugueras and Martínez concurred with economists’ warnings that when there is over-investment, historically low unemployment, and outstanding market stock exchange indexes—as is the current state in the U.S. economy—a recession is likely to follow.
The economists concluded that a major obstacle to predicting economy performance is the uncertainty that is reigning over the mainland’s short-term performance.
“We are currently living in such an uncertain landscape about what is going to happen with U.S. trade relations, with what is happening in Europe, what is happening in Latin America, what is happening in the Middle East and Russia… There is so much instability right now that we don’t know what could happen,” Brugueras stated.
For his part, Martínez said, “if we want a healthy economy, we must enter the realm of expectations, but where we are, both in Puerto Rico and at a global scale, is in the realm of uncertainty. We don’t know if the economy will drop at a given time and we don’t know, in terms of Puerto Rico, if the federal funds will be disbursed.”
By Giovanna Garofalo, Reporter for The Weekly Journal. She is a journalist with experience in social media management and digital marketing. Giovanna is currently pursuing a master’s degree in Digital Narratives at Sacred Heart University in San Juan.