National Sales Tax and Puerto Rico

A bill currently being considered in Congress is the National Sales Tax, the Fair Tax Act of 2023. Under this bill, income taxes and payroll (Social Security) taxes would be repealed and the Internal Revenue Service would be abolished. Gift and estate taxes would also be abolished. In place of these taxes, a national sales tax of 30% would be established. People buying $100 worth of goods or services would pay $130 and $30 would go to the federal government for taxes. (The bill says 23%, because $30 is 23% f $130. This special math is confusing, so we will not use it.)

A bill of this kind has been introduced in every Congress since 1999, and it has never passed the House. What if it passes this time? How would that affect Puerto Rico?

Would this apply to Puerto Rico?

Not all laws passed in Congress apply to Puerto Rico, but this one would. The bill specifically says, “The term ‘United States’, when used in the geographical sense, means each of the 50 States, the District of Columbia, and any commonwealth, territory, or possession of the United States.”

Puerto Rico currently has a different tax structure from the states. The sales tax rate is over 11% — the highest in the United States. That would shoot up to 30%.

On the other hand, income earned in Puerto Rico is not usually subject to federal income tax. All income taxes are paid to the territorial government.  Workers in Puerto Rico do pay payroll taxes, and those would end.

The end of federal income tax

Residents of Puerto Rico already do not pay federal income tax on wages earned in Puerto Rico. The bill would make no difference to income tax effects of people living in Puerto Rico. While nearly half of the people living in the states would be unaffected by this change, since they already do not pay income tax, the remaining people living in the states would get to keep more of their income.

Since few residents of Puerto Rico currently pay income taxes, this part of the bill will not have much effect on the territory. The top 1% of earners living in states are expected to save an average of $75,000 per year on their tax bills. The abolishment of the IRS will make a difference for this small number of people. The group may include some people living in Puerto Rico.

Broadly speaking, the tax will not result in an increase in income for people living in Puerto Rico.

The sales tax

Every purchase in every state and territory will be subject to a national sales tax of $30 for every $100 spent. A Puerto Rican family buying $100 worth of groceries will pay $130. Sales tax on groceries in Puerto Rico is not currently as high as sales tax on other items, but the new flat tax will apply to pretty much all goods and services equally.

State, city, and county taxes will still be allowed. Just as a city may impose sales tax in addition to the territory’s taxes, Puerto Rico and her municipalities may also have their own sales taxes. Sales taxes for people in Puerto Rico could therefore continue to be much higher than in the states.

The bill also calls for a rebate. Using a formula that calculates the amount of federal sales tax a family might pay if they lived at the poverty level, the government would send a rebate check to all families for the amount they would pay in sales taxes if they spent as much as families living at poverty level would. The best-case scenario for people living in Puerto Rico would be that they will receive a rebate equal to the amount of additional sales tax they pay.

The tax will produce increased expenses for most residents of Puerto Rico.

Fair tax?

The bill is called the Fair Tax bill because everyone will pay the same amount in extra sales tax, and everyone will receive the same rebate. “If you don’t want to pay a tax, don’t buy it. It’s as simple as that,” the sponsor of the bill said. The tax will apply to groceries, children’s clothing, and medications, which most of us would not call optional discretionary expenses.

Puerto Rico currently offers quite a few tricky tax dodges to wealthy people and corporations. These might well be affected. Would that affect Puerto Rico’s economy? It is hard to predict all the possible consequences of this change.