Marc Joffe shows how Puerto Rico's municipal inventory tax puts the island's businesses at an economic disadvantage and recommends, to address the financial impact of its elimination, that municipalities consolidate, and that the central government provide income tax credits, successfully demonstrated in other jurisdictions.
Photo: El Nuevo Día
Puerto Rico municipios levy an unusual tax that puts island businesses at a disadvantage to most of their mainland counterparts. The tax applies to the value of inventories, in the form of finished goods (those ready for sale), “work-in-process” (partially assembled products) or raw materials. It is part of a property tax regime that goes beyond real estate to impact a wide array of items owned by Puerto Rico businesses including cash on hand, materials and supplies, furniture and fixtures, and machinery and equipment.
Only nine US states fully tax inventories and another five levy partial inventory taxes. Among states that receive large numbers of Puerto Rican migrants, Florida, Pennsylvania, and New York do not have an inventory tax. But Texas does.
Like Puerto Rico municipios, Texas local governments tax the full value of inventory at their standard property tax rates. Property tax rates vary widely across the Lone Star State: although the statewide average is 1.74%, taxpayers in one jurisdiction recently faced total property taxes of 4.20%.
Earlier this year, the National Federation of Independent Business ran a campaign to lower inventory taxes in Texas. NFIB argued that the tax hurt businesses dealing with high rates of inflation and that some of the cost is passed on to consumers. In response, the Texas State Senate passed SB 5 which would have reduced inventory taxes by 20%. But the bill did not advance in the House and the legislature ultimately compromised on a property tax relief package that focused on increasing homeowner exemptions.
But even without a reduction, Texas’ taxes on inventory and other property are low compared to Puerto Rico where property tax rates range from 5.80% in Ceiba to 8.33% in San Juan and 10.33% in both Cidra and Lajas.
Aside from increasing the cost of doing business, the inventory tax imposes an extra reporting burden on Puerto Rico businesses. It is one reason why Puerto Rico received such a low score from the World Bank when it compared the Ease of Paying Taxes across jurisdictions. On this metric, Puerto Rico ranked 163rd out of 190 countries included in the World Bank survey.
And because businesses that struggle to sell their products are often stuck with more inventory, the tax hits them especially hard. As a result, the inventory tax can be the “straw that breaks the camel’s back” forcing struggling firms to close.
Business’ efforts to minimize their inventory tax liability can contribute to shortages of essential items. This is especially critical when hurricanes approach the island as families try to stock up on necessities to get through the storm’s aftermath.
Eliminating the tax on inventories without making other fiscal adjustments would impact municipio finances which are already delicate. According to CRIM, local governments collected $237 million from this tax in FY 2022. Overall, this represents about 7% of overall municipio revenue (based on FY 2020 revenue data collected by Abre Puerto Rico and updated by this author. Revenue data from FY 2021 and FY 2022 are incomplete and are unrepresentative of future totals due to the infusion of American Rescue Plan Act funds from the federal government).
To avoid exacerbating fiscal distress at the municipal level, the $237 million in lost revenue would have to be offset by increasing other taxes or by cutting spending. One cost saving I suggested in a previous article would be consolidating municipios thereby eliminating administrative duplication.
If municipios cannot find enough savings on their own, the Commonwealth government could help by providing income tax credits to offset the financial impact of the inventory tax. This approach has been implemented by the State of Kentucky, which over a four-year period phased in a nonrefundable, nontransferable credit against individual and corporate income taxes.
While a credit can relieve the financial burden of the inventory tax, it leaves the compliance burden in place. And, given both its dismal score in World Bank Doing Business Surveys and its loss of productive citizens to the mainland, Puerto Rico commonwealth and municipio governments really need to be thinking about how they can lighten the load on entrepreneurs remaining on the island or considering a return.
This article was written by CATO Institute for ILE.