FINANCIAL OVERSIGHT AND MANAGEMENT BOARD

FOR PUERTO RICO

Members
Andrew G. Biggs
Carlos M. García
Arthur J. González
José R. González
Ana J. Matosantos
David A. Skeel, Jr.
José B. Carrión III
Chair Natalie A. Jaresko
Executive Director

BY ELECTRONIC MAIL

November 2, 2018

The Honorable Ricardo A. Rosselló Nevares

Governor of Puerto Rico

The Honorable Thomas Rivera Schatz

President of the Senate of Puerto Rico

The Honorable Carlos J. Méndez Núñez

Speaker of the House of Representatives of Puerto Rico

Dear Governor Rosselló Nevares, President Rivera Schatz, and Speaker Méndez Núñez:

I write to you regarding House Bill 1544 (the “Bill”).1 As passed by the House, the Bill is
inconsistent with several provisions of the Fiscal Plan for the Commonwealth, as certified by the
Oversight Board on October 23, 2018 (the “Fiscal Plan”). While some elements of the Bill are
constructive, such as the inclusion of an Earned Income Tax Credit, many of the Legislature’s
revisions reduce our confidence that the proposals will have their intended economic effect, will
meet their administrative objectives, or will raise sufficient revenue to offset tax rate cuts. The
Bill also adds more complexity to the Internal Revenue Code of 2011, as amended (the “Code”)
and creates additional compliance and enforcement challenges.

Additionally, despite multiple requests, including our letter to you on October 18, 2018, the
Oversight Board has not yet received the underlying data needed to confirm the Bill’s revenue
neutrality. We will ultimately need to conclude with a high degree of confidence that any reduction
in certain taxes will be offset by adequate increases in taxation elsewhere in order to determine
that the Bill is consistent with the Fiscal Plan.

1
Note that we are also aware that the Senate passed the House’s proposed bill overnight and, based on public reporting,
may have included more than 100 additional amendments. This letter pertains to the version of the bill as approved
by the House. Any additional amendments from the Senate will require further assessment by the Oversight Board.

PO Box 192018 San Juan, PR 00919-2018; www.oversightboard.pr.gov; comments@oversightboard.pr.gov

Honorable Ricardo A. Rosselló Nevares
Honorable Thomas Rivera Schatz
Honorable Carlos J. Méndez Núñez
November 2, 2018
Page 2 of 4

Policy Considerations

As we have stated previously, the Bill does not address the critical tax issues, like transitioning
away from Act 154-2010, that are essential to creating a simpler, broader, more competitive, and
more sustainable tax environment to generate long-term economic growth. The Bill also does not
include other revisions to the Code that should be contemplated in light of the federal government’s
recently enacted Tax Cuts and Jobs Act.

Additionally, the Bill eliminated many of the constructive changes to the Code previously included
in the Government’s original tax bill. These changes raise new concerns, including, among others:

Further complications to the tax system – Tax administration becomes more

burdensome because inconsistencies in the tax treatment from different income
sources will likely create many compliance and enforcement challenges. The fact
that a taxpayer has the option to select the new alternative tax regime or claim
deductions does not reduce the tax administration’s obligation to audit or otherwise
verify that taxpayers are not abusing the system. Under the Bill, certified public
accountants will now have to perform audits under multiple tax regimes.

Creates adverse incentives – There are inconsistent signals sent by the proposed
income tax brackets. For example, under the new proposed flat tax regime, a
service provider with $100,000 of gross income from services would pay 6% in tax.
If that entity, however, reports $100,001 of gross income, the tax due would
increase to 10%. Similarly, businesses will face pressure to underreport revenue to
avoid paying the business to business sales and use tax, which, under this bill,
increases from 0% to 4% after a business generates $200,000 or more in sales. In
both of those examples, the marginal tax on an additional dollar of income is very
high. This will inevitably generate significant incentives to avoid, misreport and
evade the payment of taxes due.

Introduces inequitable treatment – The Bill treats taxpayers differentially

depending on how their income is derived, which is problematic across business
types and across income brackets. Depending on the facts and circumstances,
taxpayers with the same level of real income, but different income sources, could
be taxed at significantly different rates.

Inefficient tax structure – Several policies in the Bill are structured in sub-optimal
ways, which will likely affect behavior, as will the various options and differentials
in taxation. An across-the-board proportionate tax credit to individuals, for
instance, is not as optimal as a targeted modification to marginal rates.

PO Box 192018 San Juan, PR 00919-2018; www.oversightboard.pr.gov; comments@oversightboard.pr.gov

Honorable Ricardo A. Rosselló Nevares
Honorable Thomas Rivera Schatz
Honorable Carlos J. Méndez Núñez
November 2, 2018
Page 3 of 4

Areas of Inconsistency with the Fiscal Plan

The Oversight Board has concluded that the Bill is not consistent with several provisions in the
Fiscal Plan.

First, the implementation of new tax initiatives must occur sequentially, with the Government
ensuring that initiatives are paid for before rates are reduced. The Bill, however, decreases tax
rates before clearly proving that alternate payfors will generate sufficient revenues. The Bill
assumes increased collections from the new corporate alternative minimum tax (“AMT”) will pay
for the majority of proposed decreases in income taxes, SUT, and B2B. This new tax base,
however, may not materialize as anticipated because most collections come from the top brackets
of taxpayers who are least likely to switch to the new tax regime because they can likely afford to
pay tax professionals to certify the taxpayer’s eligibility for deductions under the old regime.

Second, all payfors used to offset revenue reductions must include adequate risk adjustments, for
considerations such as behavioral, economic, demographic, substitution, and implementation risks.
By removing many of the payfors originally proposed, expanding eligibility to all SUT
transactions on prepared foods, and retaining existing deductions and exemptions, the Bill has a
riskier profile than the initial bill. Consequently, larger risk adjustments than previously
contemplated are required. Proposals with uncertain levels of revenue gains will also be scored as
zero until at least one year of collections have occurred and their revenues can be measured.
Similarly, improvements in compliance related activities, or general changes that cannot be
explicitly quantified, will not be scored as measures to pay for proposed reductions in relatively
certain revenues.

Third, the Oversight Board agreed to the Government’s original proposal to decrease taxes in
certain areas immediately because the Bill contained sufficient payfors that could be quantified,
particularly limitations on tax credits and cash grants. The Bill, however, does not provide the
same level of certainty because it eliminated many of the provisions that generated fiscal balance
in the original proposal. The Bill explicitly unwinds the controls and limitations imposed on the
utilization of tax credits during the period the Tax Credits and Disbursements Authorization
Committee existed and removes provisions from the original bill that established a large taxpayers
office. The Bill must limit revenue loss vulnerabilities by restoring these provisions, starting by
restoring explicit limits on tax credits and cash grants.

Fourth, the Bill includes several provisions that are not considered as payfors for tax reductions
but are still inconsistent with the Fiscal Plan. Many of these provisions put long-term revenues at
risk or overlap with other Fiscal Plan measures. The video lottery terminal provision, for instance,
has the potential to cannibalize existing Fiscal Plan revenues. The broader authority granted to the
Department of Treasury to enter into closing agreements, and the flexibility to waive all taxes and
fees after an emergency declaration, also put future revenues at risk. Finally, the removal of the
original bill’s language broadening the definition of products qualifying as cigarettes makes it
more difficult to achieve Fiscal Plan targets.

PO Box 192018 San Juan, PR 00919-2018; www.oversightboard.pr.gov; comments@oversightboard.pr.gov

Honorable Ricardo A. Rosselló Nevares
Honorable Thomas Rivera Schatz
Honorable Carlos J. Méndez Núñez
November 2, 2018
Page 4 of 4

We also reiterate that the Oversight Board must be able to score the cost and benefit from each
proposed change to the Code before it can determine whether those changes, taken together, are
consistent with the Fiscal Plan. To do so, we require data of sufficient granularity to perform
calculations and validate all assumptions used. To date, the Government has not provided this
information.

Complex to Administer

The Bill also has the potential to significantly impact the tax structure and revenue collections of
the Government. It includes dozens of individual changes to the Code, including the imposition
of new tax regimes, new tax rate structures, new tax categories, and changes to tax exemptions and
deductions, all of which, if signed into law, would have to be implemented in a matter of weeks.
While the additional enforcement provisions in the Bill are encouraging, the late timing of adoption
of these changes will increase complexity in the administration of the tax system.

Restoring growth and prosperity is our collective priority. As drafted, however, the Bill makes it
difficult to achieve that goal. The Oversight Board is always available to work with you to correct
these deficiencies.

Sincerely,

Natalie A. Jaresko

CC: Christian Sobrino Vega

Raúl Maldonado Gautier
Teresita Fuentes Marimón

PO Box 192018 San Juan, PR 00919-2018; www.oversightboard.pr.gov; comments@oversightboard.pr.gov