Puerto Rico cannot afford statehood, which would burden the island’s citizens and corporations with federal income taxes and worsen its economic crisis.
Puerto Rico’s new delegate to Congress just introduced a bill to admit Puerto Rico as the 51st state. The Puerto Rico legislature is also considering a bill to host another statehood referendum in June.
If statehood won and the admission bill moved forward, Congress would likely consider Puerto Rico’s readiness for statehood, as it did for Alaska and Hawaii, the last two states to enter the Union. In both cases, Congress required that “the proposed new State has sufficient population and resources to support State government and at the same time carry its share of the cost of the Federal Government.” (Statehood for Hawaii, Senate Report, March 5, 1959, 7). This analysis would force Congress to deny statehood for Puerto Rico.
As the U.S. Supreme Court stated in June, “Puerto Rico today has a distinctive, indeed exceptional, status as a self-governing Commonwealth.” Under this status, individuals and corporations organized in Puerto Rico do not pay federal income taxes. This allows Puerto Rico’s government to set tax rates as high as the Federal Government’s. Thus, while individuals in the States pay 10-40% of their income to the Federal Government and 0-13% to the state, individuals in Puerto Rico pay 10-40% to the Commonwealth government.
Statehood would double the tax burden in Puerto Rico. To avoid this catastrophe, the state government would have to lower its state tax rate. But this would decrease revenue and worsen the island’s crisis. As the General Accountability Office (GAO) stated in 2014, “If Puerto Rico’s government wished to maintain pre-statehood tax burdens for individuals and corporations, it would need to lower its tax rates, which could reduce tax revenue.” The numbers are appalling.
In 2016, Puerto Ricans paid $2 billion in income taxes to the Commonwealth government. According to the GAO report, under statehood individuals would have owed an additional $2.3 billion to the Federal Government in 2009—more than double what they pay now.
Likewise, in 2016, Puerto Rico corporations paid $1.7 billion to the Commonwealth government. U.S. and foreign corporations paid $1.9 billion to the Commonwealth government. According to the GAO Report, under statehood Puerto Rico and U.S. corporations would owe between $0.7 and $5 billion more in federal taxes.
Why the uncertainty? According to the Report, “changes in federal income tax requirements under Puerto Rico statehood are likely to motivate some corporations. . . to relocate from Puerto Rico to a lower tax foreign location. The extent to which such corporations might relocate from Puerto Rico is unknown.” In other words: Puerto Rico will either pay higher taxes or lose more jobs. In addition, as was the case with the disastrous decision to eliminate Section 936 of the Internal Revenue Code, these corporations wouldn’t move to the U.S. They would likely relocate abroad. Thus, this would worsen the economic situation of the island and the states.
Aware that doubling the tax burden for individuals and corporations is a political non-starter, statehood supporters say they would adjust Puerto Rico’s state tax rates to offset the additional federal tax burden. In 1993, for example, they proposed a state tax credit to avoid doubling the tax burden.
Since the Commonwealth and Federal Tax Rates are nearly identical, one can assume that under a dollar-for-dollar tax credit, the state government would lose almost all its revenue from individual and corporate income taxes—about $3.7 billion. Moreover, the state government would be constitutionally barred from taxing U.S. and foreign corporations separately as it does now—entailing an additional loss of $1.9 billion. The state government would also lose $200 million in rum excise tax revenue that gets deposited in Puerto Rico’s Treasury but under statehood would go to the Federal Government.
In sum, the state could lose up to $5.8 billion in revenue—out of $9 billion total! That is to say that under statehood Puerto Rico would face two grim prospects: double its tax burden, or lose up to two-thirds of its revenue trying to offset the negative impact of federal taxes.
Is this a good deal for the United States? No—federal spending would increase between $1.5 and $5.2 billion according to the GAO Report. On the surface, this would appear revenue neutral. But the additional federal spending would not to go to the Puerto Rico treasury, thus Congress must consider the effects of a defunded state government.
Simply put, Puerto Rico and the United States cannot afford statehood. It is fiscally unsustainable and economically undesirable.
Pablo José Hernández is a third-year law student at Stanford Law School and blogger for Puerto Rico’s leading newspaper El Nuevo Día. He previously worked as Assistant Advisor on Public Affairs for the Governor of Puerto Rico, Hon. Alejandro García Padilla.