Puerto Rico's VAT Is A Good Idea: But It's The Residents Who Will Be Paying It

My colleague Joe Harpaz has the details of the new proposal and law that Puerto Rico will impose a value added tax on the island(s). For the details go there, my job is to talk about macroeconomics so here’s the macroeconomics of such a VAT. In general, if you want to gain more tax revenue out of an economy then a VAT is a good idea: but it should be made very obvious that it is an increase in revenues and it’s going to be the consumers, the residents, of the island that pay it. Not that that is all that unusual about tax rises: there’s only us humans around to pay taxes anyway. Sure, we can levy a tax upon corporations, or minerals, on spectrum, anything we like, but it does always end up being one or another group of humans who find their pocketbooks getting lighter as a result of the tax.

As Joe says:

In the case of Puerto Rico, a 10.5% VAT will be applied to a wide range of goods and services effective April 1, 2016. The move is part of a sweeping plan to inject $1.5 billion into the island as part of a turn-around from its recent financial crisis.
Well, a VAT doesn’t inject money into an economy, although it might inject revenues into the government cofers. But in another manner, a VAT does inject revenues. Because the deadweight costs of this type of taxation are lower than most other forms of tax.

Start with the assumption that more tax revenue must be raised. given that Puerto Rico is bankrupt but isn’t allowed to go bankrupt this sounds like a reasonable idea:




My colleague Alex Pollock does not tire of wisely reminding us of a fundamental law of finance: “Loans which cannot be paid will not be paid.” If ever that law applied, it has to be in Puerto Rico where many years of weak economic growth and poor financial management have highly compromised the island’s public finances, putting it in a position where it cannot fully honor its loan obligations. The question remains, however, whether the combined interests of Puerto Rican bondholders, and those of the island itself, would better be served within a bankruptcy framework as opposed to having creditors pursue their interests through the courts in a disorderly manner.

By now it should be clear that Puerto Rico cannot fully service its US$72 billion debt mountain even if it had the will to do so.
Maybe raising more tax money won’t work in the end but it’s at least something that has to be tried.

However, every tax, any kind of tax, reduces the size of the economy being taxed. Because there will be some economic activity that just doesn’t take place because the tax is being levied. Sure, it’s possible that what we’ll go and spend the money on is so wonderful that it will more than make up for this. But it’s still always true that the tax itself will shrink the economy. However, different taxes do this in different amounts: they have different “deadweight costs”. Land value taxes are the least, consumption taxes a little higher, then higher again income taxes, then higher than that corporate and capital taxes and then off at the far end of stupidity, transactions taxes like a financial transactions tax. As a VAT is a consumption tax (don’t be fooled that it’s companies handing over the money, the burden is really carried by consumers) it’s down at the lower end of that burden.

Tim Worstall

Puerto Rico's VAT Is A Good Idea: But It's The Residents Who Will Be Paying It

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