What’s VAT?

Almost every organization conceivable in Puerto Rico is opposing Governor Alejandro Garcia Padilla’s proposed VAT. There are public demonstrations against it nearly every day, sometimes with thousands protesting the planned new tax. But what is a VAT?

An ordinary sales tax is paid once, when the end user of the item buys the item. For example, consider a pair of shoes. The designer creates the design and sells it to the shoe company without charging sales tax. The manufacturer gets the raw materials of leather and plastics and fibers without paying sales tax. The shoes are made and sent to the shoe company with no sales tax charged. The retailer buys the shoes without paying sales tax and displays them in the store.

When you buy the shoes, you pay sales tax.

With VAT, it’s different. “Value Added Tax” means that every time value is added along the way, taxes are paid. When the design goes to a company that can make it a reality, tax is paid. When the raw materials go to a company that can make them into shoes, a tax is paid. When the shoes go to a retailer who can get them to consumers, a tax is paid.

At each point, there is a credit back to the company to make up for the taxes paid along the way. When people buy the shoes, they pay the full amount of the tax.

VAT supporters say that it’s simpler and that it’s harder to find loopholes in a VAT than in a sales tax system. VAT doesn’t have to be higher than sales tax, but it usually has fewer exemptions.

Puerto Rico’s Sales and Use tax is currently 7%, higher than more than half of the States. The governor is proposing a 16% VAT. A recent study reported a 56% compliance rate for the tax — that is, 44% of the sales tax that should be collected by the territory is not in fact collected. The tighter structure of the VAT could help with that, and the higher rate will increase the territorial government’s revenues.

But the result will be higher prices for the people of Puerto Rico – an additional 9% of the cost of an item. Secretary of the Treasury Juan Zaragoza says that he expects this to decrease purchasing in the territory — which is already in an economic depression — 10-15%.

KPMG, the company that did reports on which the Garcia Padilla Administration based the tax plan, advised that it would further depress the economy as a whole.

The Governor told a television audience that the insular government would give individuals who earn less than $20,000 a year 100% of their VAT costs through checks every four months, and people making between $20,000 and $35,000 would receive 50% of the VAT charges they pay. But his Treasury secretary later admitted that the compensation would be his agency’s estimates of how much individuals in those income groups pay in VAT charges.

And consumers won’t even know how much the VAT will cost them under the Governor’s proposed new tax system because it would prohibit merchants from showing the amount of tax on sales receipts.

With fewer jobs, businesses, and people and higher energy costs, along with a per capita income lower than that of any State, the people of Puerto Rico will find that the VAT is not a solution to the territory’s economic problems.