the million dollar question

ASKING A BILLION DOLLAR QUESTION

In a recent interview in the Wall Street Journal, Colombia’s export minister, Luis Plata, said:

“We started going to Ireland several years ago because we were looking at countries around the world that had been successful in attracting foreign direct investment. What we found was that Ireland has lowered its corporate taxes from 40 to 12.5 percent” and as a result “was attracting investment, had lowered tax evasion and had increased tax collection. We went back to Columbia and said: ‘why don’t we just bring (our corporate rate) from 39 to 12.5 percent.”

There was, in fact, no mystery how Ireland had risen from the poorest to almost the richest country in Western Europe. It did, of course, a lot of things, but the most important, as Plata and many others discovered, was lowering corporate taxes.

Now, there was a time when Colombians could have made a much shorter trip to find an “economic development model.” They would have come to Puerto Rico. In the 1960’s, linked to Columbia, Costa Rica and Venezuela as the “Latin American democratic left,” Puerto Rico’s “economic miracle” was seen as a model for President Kennedy’s and Teodoro Moscoso’s Alliance for Progress.

But since then something odd happened on this island: we became, in fact, a “model” for economic stagnation. In a column published earlier this month, Miguel Ferrer, head of UBS Puerto Rico, points to a report in the magazine Business Week that for the first time since 1885, Great Britain will surpass this year the U.S. in per capita income. Again, no mystery: one primary reason is that GB has lowered its corporate taxes from 38 to an average of 27.1 percent.
Yet, Ferrer writes, “in this same period, Puerto Rico increased the corporate tax rate and the tax load on citizens. Today we have the highest maximum corporate tax rate in the world, 42.5 percent. And the personal tax rate is also high. What have we achieved with this tax policy? We have a fatigued system that does not stimulate investment or productivity. If we continue at our present rate, the 2000 decade, that began with so much hope, will be the decade of less growth in Puerto Rico since 1950. Up to now, the real (annual) growth in the past eight years has been one percent. At this rate we do not have the capacity to attend to our needs as a people, much less to our dreams.”

So how to explain this policy? Why make Puerto Rico less, nor more, competitive -- in relation to Ireland, a country that has already lured from this island part of the crucial pharmaceutical and biochemical industries?

On March 17, 2008, the government of Puerto Rico got what it considered “good news” – Standard & Poor’s did not lower Puerto Rico’s credit rating. Gov. Anibal Acevedo Vilá had submitted to the Legislature a proposed fiscal 2009 budget with a structural $1 billion deficit. This is almost twice the current deficit of $556 million.

But S&B pointed out that when it last lowered the Commonwealth government rating to from BBB to BBB- in May 2007, it anticipated the big deficit in the new budget. The report notes with approval that the Acevedo administration is holding down spending: the new budget is the third consecutive below the fiscal 2006 level. The problem is less revenue: $464 million lower than this year. And this, of course, is a result of the deepening economic recession.

Since the Governor has proposed greatly reducing the sales tax, his administration was also pleased that S&P cites the new tax as a big reason for the recession. And, of course, it is due to the skyrocketing cost of energy and the recession in the U.S.

Needless to say, there is nothing Puerto Rico can do about the price of oil or about the U.S. recession. Many in the private sector insist that Puerto Rico must cut its huge government bureaucracy. But the S&P report warns that because public spending plays such a “dominant” role in the economy, further reductions may well make the recession worse.

So what can Puerto Rico do? There is one thing Puerto Rico can do, Ferrer and others are saying, and it will work. It will, they are convinced, begin quickly to pull Puerto Rico out of the crisis. If Puerto Rico does what Ireland and many other countries have done, lower substantially its corporate and individual tax rates, the result will be the same: it will attract new investment, reduce tax evasion and increase tax revenue.

Ferrer is proposing a gradual, three-years reduction down to a maximum rate of 25 percent for corporations and individuals. This, he says, will give the economy time to grow avoiding any immediate reduction in tax revenue.

The Wall Street Journal story on Colombia states than when Luis Plata returned from Ireland he had a hard time convincing his government to lower taxes and was only partially successful. As the newspaper put it: “Bean counters in every treasury in Latin America have tax-cut phobia in their DNA.”

The same in Puerto Rico. In fact, this island ignited its “economic miracle” precisely when, in the late 1940’s, it overcome its own “tax-cut phobia” to offer specific investment incentives. So now the billion-dollar question Ferrer and the others in the private sector are asking is: if we know that having one of the highest tax rates in the world is killing us with a prolonged economic stagnation, if we have seen Ireland and many other countries ignite their economies by cutting their taxes, why on earth don’t we do it?