By CB Online Staff
Puerto Rico should look to craft and enact a work credit tax program to replace the one that was eliminated last year due to the island government’s fiscal ills, according to a leading policy research organization.
The Urban Institute has issued a study assessing the experience with the work credit that was in effect from 2007 to 2013 and suggests elements for a possible redesign that are consistent with the goals of rewarding and stimulating work, reducing hardship, strengthening the tax base and offsetting regressivity.
The study was commissioned by the San Juan-based Center for a New Economy thanks to a grant received from the Open Society Foundations and Espacios Abiertos.
Puerto Rico lawmakers enacted the work credit in 2006 to offset the regressive nature of the commonwealth’s sales & use tax (IVU) that was established in that same year. In addition to helping offset sales tax regressivity, refundable tax credits tied to work such as the work credit have been found to reduce hardship and stimulate employment among low wage workers. In 2013, the work credit delivered benefits to 45 percent of all tax filers at a cost of $124 million. In 2014, as Puerto Rico slid into its deepest fiscal crisis in recent history, lawmakers eliminated the credit.
“Cost-saving measures to solve the fiscal crisis trumped thoughtful analysis of how the WC program worked, how it could be improved, and how it relates to other to broader economic goals,” the Urban Institute said.
The report acknowledged the Puerto Rico government’s plans to unveil and implement a sweeping tax reform in the first quarter of 2015.
Tax reform discussions in Puerto Rico point toward adoption of a value-added tax, elimination of income taxes for the vast majority of Puerto Ricans, and refunding at least part of the value-added tax to certain families.
“Enactment of a tax reform with these features does not render mute the work credit because this credit does more than offsetting consumption tax regressivity. It reduces hardship, promotes employment and lightens the tax burden of payroll taxes on low and middle income working families,” the Urban Institute said.
In a value-added tax system with refunds and limited income taxes, policy makers would have to design mechanisms to deliver the WC to qualifying families. Possible mechanisms are: payroll checks; simplified income tax returns; the system Puerto Rico’s government utilized to implement in the Making Work Pay program in 2009 and 2010; and a new refund mechanism that might be developed under a value-added tax system.
The employment level of Puerto Rican households is low; only 54 percent of Puerto Rican households had workers with wages between 2010 and 2012.
Among households with dependent children and working-age heads, 30 percent had incomes between $10,000 and $25,000; and among those with wages, 29 percent received benefits from the Nutritional Assistance Program.
The share of income taxes paid by families with incomes under $30,000 dropped from 23 percent in 2000 to 3 percent in 2012. The average income tax bill for these units was $81 in 2012.
The work credit brought families into the tax system. In the year it was introduced, the number of tax units within the income limits of the WC grew by 6 percent—more than the growth in tax filing units with higher income.
Because of its small amount—$450 at its maximum—the work credit made only a small dent in raising the earnings of families, but because of its broad coverage, many people received the credit. In 2012, 469,258 tax returns, or 45 percent of all tax returns, claimed the work credit.
As stated in the law that created the work credit, the credit was “similar to the earned income tax credit [EITC] in the United States.” However, on closer inspection, the credits were quite different. One notable difference between Puerto Rico’s credit and the federal EITC is that Puerto Rico’s income eligibility limits were based on individual earnings whereas the federal credit was based on tax-unit earnings. In addition, contrary to the federal EITC, the work credit did not differentiate among claimants by filing status, presence of dependents, or age of the tax filers.
Although two minimum wage increases and various changes in the credit amount occurred after the introduction of the work credit, the income level at which the credit reached its maximum remained at $10,000 for the seven years the program was in existence.
A family-centered work tax credit program that targets families with children, headed by working-age persons, with income eligibility limits between $7,500 and $25,000 could benefit working families, the Urban Institute said.
“This design is consistent with the goals of rewarding and encouraging work and offsetting sales tax regressivity,” the report found.
Although tax units identical to those that will claim the credit cannot be re-created with the available data, it is estimated that this redesigned credit could benefit from 119,000 to 128,000 families.
If such a credit reaches it maximum at incomes between $15,000 and $16,000, simulations with phase-in rates of 4 to 12 percent of income show that the cost of the program would be between $60 million and $278 million, depending on the rate at which the credit reaches it maximum and the rate at which it declines after reaching the maximum.
The Urban Institute said any work credit program enacted should incorporate flexibility in its design and application to accommodate changing fiscal circumstances, expansion to additional population groups, or expansion of benefits.