NTA NETWORK

 

 

Puerto Rico and the Other 'Balance of Payments'
David Brumbaugh*

 Those of us who live or work in Washington D.C. are used to debates that connect taxes and political status — the District’s license plates bear the inscription “taxation without representation,” calling attention to D.C.’s lack of full-fledged participation in Congress.  For Puerto Rico, the  status issue is just as sharp, and involves the very question of nationality.  And the matter of Puerto Rico’s relationship with the United States is inextricably tied to the question of tax and spending relations between the federal government and Puerto Rico.  While the term makes international economists wince, this issue has come to be known as the “balance of payments” question.

Puerto Ricans have long debated the merits of three alternative status options: full U.S. statehood; independence; or continuation of the current hybrid “commonwealth” status.  Over the past 40 years, Puerto Rico has conducted three plebiscites and one referendum on the matter, and status is a continual focus of political debate both on the island and in the U.S. Congress.  Non-tax issues in the debate are numerous and complex, and include topics such as self-determination, language and culture, and likely congressional representation, to name only a few.  But a change in Puerto Rico’s status would change the applicability of federal tax and spending programs.  As a result, a persistently prominent element of the debate is how a change in status would change the balance between federal outlays on the island and Puerto Rico’s own federal tax payments.

Puerto Rico is a U.S. territory, but since 1952 it has had its own constitution and a measure of autonomy as a “commonwealth.”  Puerto Ricans are U.S. citizens, but cannot vote in Presidential elections; Puerto Rico has a non-voting representative in Congress.  In the area of taxes, Puerto Rico has considerable autonomy in tax matters, and applies its own tax system.  Under federal tax law, residents of Puerto Rico generally do not pay federal income taxes, although social security taxes do apply.  On the business side, corporations chartered in Puerto Rico are considered “foreign” under the federal tax code and can use the same “deferral” tax benefit available to U.S. firms investing in foreign countries.  (An alternative, more generous  federal tax benefit—the possessions tax credit, or Puerto Rican economic activity credit—is available through the end of 2005, but will then expire under terms of federal legislation enacted in 1996.  For decades, the economic merits of the credit, was a key part of the status debate, because the credit would not apply under statehood.  While the credit’s scheduled expiration may not make fiscal relations a less important part of the debate, they at least make them less complicated.)

Like taxes, federal spending programs are not fully applicable in Puerto Rico.  For example, the federal food stamp program and supplemental security income (SSI) programs do not apply, while TANF and Medicaid are capped.  With the full applicability of federal programs under statehood, outlays would expand.  The “balance of payments” question, then, is this:  If Puerto Rico were to become a state, would the increase in federal spending outstrip the increase (if any) in federal tax payments?  

Compared to the 50 states, Puerto Rico is poor; median income is only 46% that of Mississippi, the poorest U.S. state.  The island’s relative poverty and the progressive nature of the federal tax system and spending programs makes the answer to the balance of payments question  clear: the increase in spending under statehood would outstrip new federal tax payments; there would be in all likelihood an increase in the net flow of federal funds to the island. 

Rough calculations based on 2003 data suggest that if federal spending in Puerto Rico were to increase to the rate of outlays in Mississippi,  they would be about twice the level of federal outlays under commonwealth status — around $14 billion.  Taxes likely would not begin to offset this amount; if individual income taxes in Puerto Rico were paid at the Mississippi rate they would be slightly over $2 billion.  Given provisions such as the earned income credit, the actual tax figure would likely be much lower.  The revenue pick-up from federal business taxes would be unlikely to make up the difference, especially with the scheduled expiration of the possessions tax credit.

Federal tax and spending policies are complex, and add yet another dimension to the already-complicated question of Puerto Rico’s status.  Yet in the case of fiscal relations, the direction of statehood’s effect seems clear.

*David Brumbaugh is an economist with the Congressional Research Service.

Tax Policy and the Economy
The National Bureau of Economic Research and the NTA is offering, as a courtesy to the NTA’s membership, the 2005 volume (no. 19) of Tax Policy and the Economy from MIT Press.  This publication is being distributed exclusively to NTA members and will be mailed at the end of August.

 

Allied Social Science Association

The NTA will again sponsor a session at the Allied Social Science Association Program in association with the AEA meetings which will be held in Boston next year (January 6-8).  Bob Bohm of the University of Tennessee has again organized the NTA session.

Title:  Issues in Interstate Competition and Policy (H710)

Presiding: Jonathan C. Rork, Vassar College

“How Do States Formulate Medicaid Policy?” Reagan Baughman, University of New Hampshire and Jeffery Milyo, University of Missouri-Columbia

“Cross-Border Shopping and the Sales Tax:  A Reexamination of Food Purchases in West Virginia.” Mehmet Tosun, West Virginia University and Mark Skidmore, University of Wisconsin-Whitewater

“Dynamic Scoring of State Reform Proposals,” Paul Coomes, University of Louisville and William Hoyt, University of Kentucky

Discussants:
Brian Hill, University of Tennessee-Knoxville
Claudio Agostini, Universidad Alberto Hurtado
Robert Rebelein, Vassar College

Research News

Julia Coronado, senior research analyst and Sylvester J. Schieber, research director at Watson Wyatt Worldwide wrote an article about the Bush administration’s proposal to encourage employers to fully fund their pension plans.  The study, Saving Private Pension Insurance: An Evaluation of Current Proposals to shore up PBGC, was published in the Journal of Compensation and Benefits.  A full text of the article is available by calling the NTA’s office.

Welcome New Members Summer 2005
Annette Alstadsaeter, Statistics Norway, Oslo, Norway
Mary J. Balmer, Best Software, Herndon, VA
Helena Blazic, University of Rijeka, Rijeka, Croatia
Gregory S. Burge, Florida State University
Thomas Carton, Ohio Department of Development, Columbus
Philip DeCicca, University of Michigan, Ann Arbor
Robert J. Eger III, Georgia State University, Atlanta
Patterson C. Ekeocha, University of Nigeria, Nsukka, Nigeria
Pamela Hannigan, New York University, New York, NY
Andy Hultquist, Ohio State University, Columbus
Sung-Hee Jeon, McMaster University, Ontario, Canada
Steven R. Kelley, Ohio Department of Development, Columbus
Xin Li, University of Michigan, Ann Arbor
Kung-Cheng Lin, Feng Chia University, Taichung, Taiwan 
Byron Lutz, Massachusetts Institute of Technology, Cambridge, MA
Carrie Manno, Ohio Department of Development, Columbus
Robert W. McGee, Andreas School of Business, Barry University, Miami Shores, FL
John Mlckovsky, Ohio Department of Development, Columbus
Xiaoyi Mu, University of Oklahoma, Norman, OK
Sheila Murray, RAND, Arlington, VA
Rainer Niemann, University of Graz, Graz, Austria
Charles A. Pier, Appalachian State University
Doreen Rae, University of Texas, Arlington
Laura Rooney, Arizona State University, Tuscon
Benjamin Russo, University of North Carolina, Charlotte
Kent Smetters, Wharton School, University of Pennsylvania
Robert Stempfer, Ohio Department of Development, Columbus
John A. Swain, James E. Rogers College of Law, University of Arizona, Tuscon
Laura Ullrich, University of Tennessee, Knoxville
Marcia Van Wagner, Office of the Comptroller, New York, NY
Laura Wheeler, Andrew Young School of Policy Studies. Georgia State University, Atlanta

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Jane G. Gravelle
Congressional Research Service
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Vice Presidents
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Robert Tannenwald
Federal Reserve Bank of Boston
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Ernst & Young LLP
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Gary C. Cornia
Marriott School of Management
Brigham Young University
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Texas Taxpayers & Research Association
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Leonard E. Burman
The Urban Institute
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Stacy Dickert-Conlin
Center for Policy Research
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Syracuse University
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     Stacey Johnson
Iowa Taxpayers Association
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Douglas Lindholm
Council on State Taxation
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     Lillian Mills
University of Arizona
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     Pamela Moomau
Joint Committee on Taxation
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James R. Nunns
Office of Tax Analysis
U.S. Department of the Treasury
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Gary Sasse
RIPEC
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     Daniel N. Shaviro
New York University Law School
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Eric J. Toder
The Urban Institute
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Sally Wallace
Andrew Young School of Policy Studies
Georgia State University
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Deloitte Tax LLP
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Paul A. Wilson
Minnesota House of Representatives
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Rice Scholar
Baker Institute for Public Policy
Rice University
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ADVISORY MEMBERS

Harley Duncan
Federation of Tax Administrators
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Richard Lavine 
Center for Public Policy Priorities
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Lynn Edward Reed
Minnesota Taxpayers Association
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Francois Vaillancourt
Department of Economics
University of Montreal
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Montreal Quebec H3C 3J7 
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Joan Youngman
Lincoln Institute of Land Policy
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NATIONAL TAX JOURNAL

Rosanne Altshuler (9/04-8/05)
Dept. of Economics
Rutgers University
New Brunswick, NJ
altshule@rci.rutgers.edu

Therese J. McGuire
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston IL 60208 
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 EXECUTIVE DIRECTOR

J. Fred Giertz
Institute of Government & Public Affairs
University of Illinois
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Staff: Charmaine J. Wrightt