A History of Crisis
Puerto Rico, a Commonwealth Territory of the United States, was obtained by the U.S. in 1898. The modern era of Puerto Rico as a territory began in 1952, with the establishment of a republican government after ratification by Puerto Rican voters.
Through efforts known collectively as “Operation Bootstrap,” Governor Luis Munoz pursued an ambitious strategy to create a modern industrial economy while drastically reducing the island’s dependence on small-scale farming operations. On its face, the program worked: the importance of agriculture in the economy dwindled, and export trade of manufactured goods grew immensely. This prosperity proved hollow, however, because of its reliance on corporate tax exemptions, which proved prohibitively expensive for American taxpayers.
Reformers seized on the enabling IRS tax code, Section 936, portraying it as not only a waste of money, but as creating an undesirable motivation for U.S.-based corporations to move their operations off the mainland and onto the island. Finally, in 1995, President Bill Clinton signed legislation to phase out Section 936 over the span of a decade (1995 to 2006).
The elimination of Section 936 marked the beginning of a steady decline in Puerto Rico’s wages and overall employment levels, a trend which was made significantly worse by the 2008 recession.
With workers’ earnings in decline, the island’s tax receipts contracted sharply in this period, and in this atmosphere of crisis, the island’s government turned to bonds to bridge the gap. A unique provision dating from 1917 held that bonds issued by Puerto Rico were tax-exempt at the local state and national level.
Even in the face of Puerto Rico’s weakened economy, high unemployment rate, and crumbling infrastructure, this “triple exempt” rule made Puerto Rican bonds an exciting product. Eager to collect high yields from the Commonwealth while avoiding the many taxes associated with other municipal bonds, investors flocked to take advantage of the opportunity. Although they provided a “shot in the arm” of funds at a time when they were desperately needed, the long-term effects of the bonds on Puerto Rico’s have been devastating, and in 2017, the government entered into a bankruptcy-like process, a major portion of which was focused on the many billions of dollars of bond debt that could not be repaid.
Already reeling, several blows delivered by nature seemed to seal the island’s fate. Hurricanes Maria and Irma devastated Puerto Rico in 2017, leaving significant portions of its infrastructure compromised, much of which has yet to be fully restored.
An Alternative to Crisis: Tax and Assessment Reform
In 2018, Josh Vincent, Executive Director of the Center for the Study of Economics, was introduced to Victor Ramirez, a software engineer, planner, and Puerto Rican resident, seeking solutions to the island’s ongoing distress. With Victor’s knowledge of tax policy and Josh’s extensive experience working with States and municipalities interested in creating more stable, progressive revenue streams by better capturing the value of public investments made manifest in local land values, their mutual interests were clear.
A subsequent examination of the effects on the Puerto Rican economy of fostering a greater reliance on the real property tax revealed that although the implementation of land value taxation (LVT) would benefit rural and urban working neighborhoods (and incentivize capital-intensive development on potentially valuable sites) the reality of real property assessments with less than ideal.
Puerto Rico was last formally assessed in 1958; and although a property tax was in place, the passage of time had distorted the critical relationships and improvements and the land. LVT would provide marginal tax relief and would penalize bladed, and vacant land, but the experience of LVT implementation in Pennsylvania had clearly demonstrated the need for up-to-date and continually updated valuations of land and buildings.
For example, the city of Altoona Pennsylvania enacted LVT in 2002. Although the city eventually eliminated the real property tax on improvements, the existing assessments (coincidentally) also dated to 1958, and LVT’s impact was muted. In the absence of significant demonstrated benefits, the holders of valuable vacant land were able to successfully agitate against LVT, leading to its abandonment in 2015.
Fortuitously, the Commonwealth government recently released a study on reassessment in Puerto Rico. Recognizing this as a real opportunity to introduce the idea of LVT to government officials, Ramirez procured a daylong symposium on its theory and practical applications. He sought out his former planning professors, who happily sponsored, hosted, and participated in the event.
In April 2019, at the invitation of the Department of Planning at University of Puerto Rico, Rio Piedras Campus, Josh Vincent flew to Puerto Rico to participate in the panel. Together with Victory and the other expert panelists, he explored options for financing the rebuilding of the island after the twin hurricanes, and discussed a number of other other pressing issues on the island.
Norma Peña, Director of the Graduate School of Planning, University of Puerto Rico
Gerardo A. Navas-Dávila, Professor at Graduate School of Planning, University
of Puerto Rico
Reinaldo Paniagua Latimer, Executive Director of the Municipal Revenue Collection Center
Victor Ramirez, Analyst and Robert Schalkenbach Foundation Board Member
Josh Vincent, Executive Director, Center for Study of Economics
With so many challenges facing Puerto Rico, the panel’s discussion was wide ranging, and included topics such as:
– Current bond debt and unfunded pensions amount to about $125 billion. Revenues from the sales tax collateralize the debt.
– There is no guaranteed revenue stream to rebuild infrastructure.
– The Commonwealth government has made its books look good by reducing aid to municipalities.
– Towns have little own-source funding. That which exists are volatile taxes such as sales.
– Cost of living is high on the island, straining the largely impoverished populace’s ability to meet basic needs.
Take-Aways and Next Steps
The discussion was lively, with participants and audience members presenting a variety of views, some of which were at odds with one another. It is clear, however, that the implementation of LVT could have significant benefits for the island, and the timing of the proposed reassessment is highly advantageous, leaving both Josh and Victor with the impression that more can and should be done to promote its adoption in Puerto Rico.
As Josh Vincent put it in his final report to RSF: “With an impending reevaluation for the island now is an excellent time to research the various possible outcomes of property taxation. Naturally, I believe that LVT would likely be a less distortionary and more progressive tax regime, but time and the data will tell.
Since the island’s budget depends to a high degree on the Sales and Use Tax (IVU for its Spanish acronym) and the Commonwealth income tax and corporation tax, having a fair, accurate, and scalable property tax valuation system is essential, and we commend the Commonwealth for pursuing this new system.
Rebuilding an economy based on revenue sources traditionally stressed in bad times must be avoided.
Tax shifting from labor and capital onto economic rent of land can provide stable revenue, can remove the economic drag (or deadweight) on the island and also counterbalance adverse effects of sales taxation, energy costs, and the Jones Act.
Municipalities ought to have much more freedom to self-source their revenue. Cities ought to be able to choose what type of tax works best. Towns are closer to their citizens than the Commonwealth. Essential decisions on zoning, planning, and infrastructure have to come from the ground up.”
The Robert Schalkenbach Foundation looks forward to continuing to support Josh and Victor’s forthcoming efforts to promote the implementation of LVT in Puerto Rico.