Romero Barceló calls for permanent tax on multinationals, improved public education

Former governor says high cost of energy and permitting delays still the biggest barriers to economic development

For Carlos Romero Barceló, every sector of the economy must pay its fair share in taxes, and the government needs to dramatically improve its permitting system and bring down the cost of energy.

Only then, he said, will Puerto Rico be able to rediscover a path toward sustainable economic development and make the kinds of big steps needed to improve the quality of life on the island for all Puerto Ricans.

In a wide-ranging, exclusive interview with CARIBBEAN BUSINESS, the two-term former governor, resident commissioner and San Juan mayor also discussed why he believes the upcoming status plebiscite is a mistake, why the recent tax reform was unnecessary and why fixing the island’s broken public education system is the single most important thing the government can do, a move that would not only spur a strong economy, but also attack the worrying crime problem at its roots.

He also hailed the extension of the U.S. minimum wage to Puerto Rico as the No. 1 act of social justice that took place during the past century and warned against the island trying to act on its own to sidestep federal restrictions such as the maritime rules under the Jones Act.

REFORMING TAXATION

«When a sector of the economy doesn’t pay its fair share, it creates resentment in the public,» Romero Barceló said. «A society can’t live with an unjust tax system.»

It was more than 30 years ago that Romero Barceló as governor first decided to tax multinational firms operating on the island, although up to 98% of a firm’s earnings remained tax exempt.

Romero Barceló recalled the battles he had over the move, even with allies within the New Progressive Party (NPP), but noted manufacturers actually expanded operations on the island during that time. Although his plan was to continue increasing the tax, subsequent administrations never followed through. Yet, that 1% or 2% tax that multinationals have paid here over the years has made up the bulk of corporate tax collections over the years.

Today, Romero Barceló believes the most recent excise tax on multinational manufacturers operating here, Law 154, imposed in October 2010 by the administration of Gov. Luis Fortuño, should be made permanent.

«I support a 10% permanent tax on net income of Controlled Foreign Corporations [CFCs],» said Romero Barceló, who served as NPP president for 11 years.

The excise tax on CFCs currently imposed under Law 154 has become a critical part of general fund revenue, providing some $1.8 billion a year, but the tax rate will be diminishing during the next five years until it disappears in 2017, creating a need for a recurrent source of revenue for the government.

An excise tax is imposed on such nonresident alien individual or nonresident foreign entities that acquire personal property and services from related sellers. The excise tax rate was 4% for purchases during calendar year 2011, and was reduced this year to 3.75%. In subsequent years,it will be reduced to 2.75%, 2.5%, 2.25% and 1%, and then for calendar year 2017 the excise tax will no longer be in effect, being subject to the source of income rule thereafter.

«This excise tax doesn’t cost anything to these tax-exempt companies as they get a federal tax credit to offset what they pay the Puerto Rico government,» Romero Barceló said.

The issue of a permanent tax for multinational manufacturers, however, is more than just a question of dollars and cents for the statehood advocate and political veteran. Paying taxes shows a level of commitment to Puerto Rico that a business should make to the island to operate here, he said. Paying taxes is a way for a company to invest in adequate infrastructure and the public education system, which are as essential to its success as they are to society at large.

«They need to commit,» Romero Barceló said. «If it’s just a question of not paying taxes, then they will get up and move whenever they get a better offer. That’s what’s been happening.»

Although Romero Barceló supports the imposition of a sales & use tax (IVU by its Spanish acronym), he insisted that the 7% rate imposed by the previous administration of former Gov. Aníbal Acevedo Vilá was implemented in an illegal manner.

Under former House Speaker José Aponte, the House was pushing for a 5.5% rate, but the legislation was changed after it was brought down to the floor so that a 7% rate was imposed in a case that was decided by the Puerto Rico Supreme Court, Romero Barceló said.

«In the report that the House Treasury Committee submitted to the floor of the House of Representatives, nowhere was there mention of a 7% tax,» he said. «What it said was that the [IVU] would be 5.5% and with a parentheses specifying 4% for the central government and 1.5% for the municipalities.»

«Nevertheless, the Puerto Rico Supreme Court, then controlled by Popular Democratic Party appointees, decided on the 7% IVU tax, which I believe was a shameless deception by the Supreme Court,» he added.

Although the IVU is a good tax because it taps revenue from the underground economy, the rate of 7% (5.5% for the central government and 1.5% for municipalities) is too high for the middle class and working poor, the former governor said.

While current government finances probably won’t allow a reduction in the IVU rate right now, Romero Barceló is calling for greater exemptions from the IVU tax on items that are essential for the middle and working classes. Because most middle-class families are barely getting by, it is important to lower their tax burden, he said.

The impact of these deductions would be covered by the 10% tax imposed on tax-exempt companies.

In fact, Romero Barceló believes a permanent tax on multinationals could bring further relief to taxpayers through increased deductions.

The former governor also said the Puerto Rico Legislature has the ultimate authority to levy taxes, which takes precedence over any tax decree into which a company may enter with the Treasury or Economic Development secretary.

«Tax decrees aren’t worth the paper they are written on,» he said.

He criticized the recent tax reform because he said too many of its benefits flowed to high wage earners and businesses, and not enough relief was delivered to the working class. Moreover, he said, it failed to benefit the unemployed, who have been under enormous financial pressure during Puerto Rico’s six-year recession.

Administration officials have hailed the tax reform as a «game-changer» that will «fundamentally» improve the investment climate for all businesses operating on the island. The average 30% tax cut for businesses took full effect this year, while an average 50% cut for individual taxpayers will be phased in over the next six years.

The largest and most sweeping tax reform implemented in recent memory, it delivers three times the tax relief given to taxpayers in the 1994 reform. Designed to reward hard work and investment, its big winners are salaried workers and local businesses, which officials say have borne more than their fair share of the island’s tax burden over the past several decades.

Such «unprecedented relief» has been promised to both individual and corporate taxpayers since the enactment of the IVU in November 2006.

The tax reform will deliver about $1.2 billion in annual relief for individual taxpayers over the next six years—an average $1,500 per taxpayer. It will also provide an average annual $260 million in corporate tax relief over that period.

Romero Barceló, however, said simply increasing deductions would have provided more relief to the working class.

«I thought the tax reform was unnecessary,» he said. «Increasing deductions would have done it.»

Rather than overhaul the entire system, Romero Barceló would have called for an increase in deductions to $4,000 for individuals and $8,000 for couples to help cope with the increasing cost of living during these tough economic times.

He also would have added deductions to help island families cope with the standard costs most families need to bear. These include the cost of private education up to 12th grade, the burden of which could be eased through a deduction of up to $8,000 annually as well as 100% of the costs of health insurance for individuals who don’t receive such coverage at work.

‘OUR WORST OBSTACLES TO INVESTMENT’

«Energy and permitting are our worst obstacles to investment in Puerto Rico,» Romero Barceló said, adding that these twin threats have been problems for decades. «The short-term solution to the high cost of energy has to be natural gas. It will help our environment and lower energy costs.»

Already twice as cheap and clean as petroleum, natural gas will be the fuel of choice for years to come because of vast reserves in the U.S. and Canada. Once the U.S. begins exports in 2015, the cost of the fuel will come down even further, energy experts say. The former governor sees natural gas as the best and fastest solution to Puerto Rico’s energy-cost problem as it also ventures into wind, solar and other forms of renewable power.

The veteran political leader said questions of how to best transport the gas need to be analyzed. He said while many of the complaints about the proposed 91-mile Vía Verde pipeline are «exaggerated,» there were probably legitimate concerns regarding its construction in certain areas, such as the mountainous interior of the island.

«These questions are better addressed by engineers and architects, not environmentalists,» Romero Barceló added. «Building a pipeline might be an environmental problem, but once the pipeline is built, what is the problem?»

He recalled that much of the opposition in the States many years ago to the Alaskan oil pipeline centered on the potential harm it could cause to native caribou (a large North American reindeer), with much of the outcry coming from the Eskimo people indigenous to the region. Providing royalties to the Eskimo groups helped win their support, and today, caribou actually benefit from the pipeline because it offers a warm, sheltered area where they can safely feed their young, the former governor said.

Besides diversifying away from imported oil for power generation, cutting back on subsidies to government entities and giving the Puerto Rico Electric Power Authority (Prepa) more teeth in collecting back debts from them are other essential ingredients in bringing down power costs, the former governor said.

He added that the government needs to transform the operations of Prepa, which has for years been hostile to the development of new energy sources, he said.

«Something has to be done with Prepa,» Romero Barceló said. «They say they want wind energy and solar energy, but go to Prepa and see what happens. The obstacles are incredible.»

Romero Barceló said developers will often negotiate agreements with Prepa, and upon reading the first draft of the accord, find that all its terms are dramatically different from what has been discussed.

Or, he added, Prepa officials will send developers through endless hoops, requesting documentation and other requirements that make doing business with the public corporation a painful experience.

«The process is just to discourage you from doing the project,» he said. «It is something that is ingrown in the structure of Prepa.»

Romero Barceló said the big change could come through effective management of the government power utility, rather than overhauling its legal structure or putting it under an outside regulator.

«The problem has to be tackled,» he said. «You need a board and executive director who are willing to take the heat to do what needs to be done.»

PERMITS PROCESS STILL GIVING P.R. A BAD NAME

Despite a huge overhaul of the permitting system by the current administration, Romero Barceló said Puerto Rico’s permitting process continues to be a «monster.»

While he said the blueprint of the new law looks good on paper, in practice the permitting process continues to create obstacles.

«It disincentivizes construction and gives Puerto Rico a terrible name,» he said.

The new law, he said, is being «sabotaged by rank-and-file bureaucrats at the agencies who keep asking for a document here and a document there. It’s horrible. The law isn’t working.»

He said the permits process needs to be more efficient, asking how much time it takes from the time a developer decides to build a hotel to the time it is inaugurated.

«It is incredible,» the former governor said. «Neither the Tourism Co. nor the Puerto Rico Industrial Development Co. helps. They say they help, but they don’t. Ask anybody trying to build a hotel how long it takes.»

Romero Barceló said he continues to experience permitting problems on a first-hand basis in his private, professional life.

«And I have access to the boss,» he said. «Other people don’t.»

He said the permitting process remains so bad that it is hindering the fl ow of outside capital to Puerto Rico.

«There is no worse hindrance to investors coming to Puerto Rico than making everything an obstacle, making everything take time,» he said.

Other government services that could be made more efficient include the collection of taxes through the central government Municipal Revenue Collections Center (CRIM by its Spanish acronym), Romero Barceló said. CRIM has been inefficient, he contended, because it has introduced the political element to property tax collections, which he believes the Treasury Department should handle.

«Certain towns with certain populations can hire their own employees and collect the funds,» he said.

Regarding whether he supports the creation of a county system or the regionalization of services to make municipalities more efficient, Romero Barceló said he believes municipalities could form consortiums, as some have already done to consolidate solid-waste collection and other services. He believes reducing the number of municipalities in Puerto Rico from the current 78 would be impossible.

«Politically, you can’t do that because you are going against local pride,» he said. «However, some form of a county system, as exists in the States, should be looked into seriously.»

BLOCKING THE FLOW OF CAPITAL

Romero Barceló believes local laws requiring the owners of companies in certain professions to be licensed members of the profession limit economic development and access to capital. For example, the owners of a real-estate company must all be licensed real-estate agents.

This issue has regained attention in recent weeks with reports that NPP Sen. Roger Iglesias and the father of Senate President Thomas Rivera Schatz both own companies that require the owner to be a licensed professional. Neither of the two is licensed, according to press reports.

«I think it is absurd that investors aren’t allowed to own companies that engage in certain professions without the investors themselves being members of that profession,» Romero Barceló said. «This closes off a potential source of financing that has the potential of injecting millions of dollars of investment into our economy.»

Romero Barceló said the legal requirement has the potential to create inheritance issues and other drawbacks.

«If I founded a corporation that engages in the practice of, for example, the sale of real estate, and I die, what happens to the corporation? It can’t be inherited by my family because they are not licensed real-estate agents,» he said. «They should be allowed to inherit the corporation and hire duly licensed agents to consummate the real-estate transactions of the firm.»

Other professions similarly limited by the law include architecture and engineering.

«I believe architects, engineers and members of other professions should have the right to reach out to investors to set up offices, as long as licensed professionals are the ones doing the work,» the former governor said. «By not doing so, we are limiting our competitiveness in projects on a national and international scale.»

Romero Barceló further noted there are dozens of contractors and developers out there working on projects who are neither architects nor engineers.

«If we want to compete with large companies abroad, we have to allow capital investment,» he said.

In the healthcare industry, there is no such requirement, he added, noting that the chief executive of HIMA-San Pablo Hospital, Joaquín Rodríguez, isn’t a doctor, and it is the same with many other industries.

BEYOND TAX INCENTIVES

Romero Barceló went on to say income-tax breaks aren’t the most effective economic-development incentive nowadays. He said he would eliminate income-tax exemption for island hotels and replace it with other incentives aimed at lowering operating costs.

«All these credits do is keep hotels from having taxable income against which to offset capital investments and maintenance improvements, so they don’t stay in tip-top shape,» he said. «That’s what happened to us when I was governor. We had several hotels that preferred to repatriate their earnings and take the money out of Puerto Rico instead of reinvesting it right here in their facilities. But why should they reinvest? There’s no incentive.»

Trickle-down economics, he added, doesn’t work in Puerto Rico, given the island’s low per capita income.

«That might work in the States, where incomes are much higher, but not here,» he said. «Let these big companies and hotels pay their income tax and let’s use that money to lower taxes for the middle class. That’s how you get that money to circulate in the economy.»

Romero Barceló suggested incentivizing hotels by offering a policy suite that helps them lower Puerto Rico’s high operating expenses.

Topping the list is what he describes as «extraordinarily high» energy costs. While direct subsidies of power bills might prove too expensive, he insists there is room for other creatively structured incentives.

For instance, the government could «help hotels install [smart building] systems like hotels in Europe have, where the lights go out when you leave the room,» he said. «Here in Puerto Rico, when a guest leaves a room, everything stays on— the lights, the air conditioner—all day long,» he said. «That’s a very high expense. So measures like that, which may be small, could add up.»

Romero Barceló’s questioning of the effectiveness of corporate tax breaks goes back to his two terms in office as the governor of Puerto Rico, when he became convinced wage credits were a more effective driver of economic development than tax incentives contained in Section 936 of the federal Internal Revenue Code. The tax section then conceded close to a 100% tax exemption for manufacturing operations in Puerto Rico, with a small tollgate tax applied on funds repatriated to the U.S. mainland. It didn’t matter that in many cases there were relatively few jobs created in relation to the tax-free earnings.

«I became convinced the only ones benefiting from tax credits were those companies that were receiving them,» Romero Barceló said, referring to Section 936. «The tax credits no longer had a positive impact for Puerto Rico. Jobs were already leaving for lower-wage countries that were also offering incentives. And the cost of creating jobs for Puerto Rico and the U.S. mainland was immense. In those days, it cost us and the federal government more than $100,000 for each job created.»

The simple math of those assertions drove Romero Barceló to push for an incentives plan for job creation through wage credits, not just because it made good sense for development, but also because he considered it unjust that those making the most were paying the least.

«The tax breaks create a sense of injustice among the people, who say, ‘Why should I have to pay so much in taxes when those with so much more do not?'» the former governor said.

He recalled his drive to rebuild an eroding tax base drew strong opposition from NPP leadership.

«They told me that it can’t be done, as if there were some contract with the companies,» Romero Barceló said. «Their thinking goes against the powers vested in state legislatures to establish and impose taxes. Our Constitution established that right, and you had lawyers in the Golden Mile [local financial district] running around, saying ‘Oh, no, that can’t be done; that is a legal and moral contract.'»

Romero Barceló sought to build consensus by imposing the tax on a progressive basis, with incremental increases over time: first, on 10% of income; then, on 25%; then, 50%; then, 100% of earnings.

While the policy cost Romero Barceló the election in 1984, he recalls contemplating a move toward wage credits as a possible alternative.

In his return to Puerto Rico politics as Puerto Rico’s resident commissioner in Washington, D.C., Romero Barceló had the opportunity to put his taxation philosophy into practice.

«When I arrived in Congress in 1993, I realized that Section 936 had a death sentence,» the former congressman said. «It had been labeled corporate welfare by the federal agencies and the press, and the writing was on the wall. So I sought to obtain wage credits instead.»

Romero Barceló’s crusade for Section 30A wage credits found opposition from Álvaro Cifuentes, former Gov. Pedro Rosselló’s chief of staff, who was a supporter of the influential pharmaceutical lobbying machine on K Street in Washington, D.C.

«Cifuentes told Rosselló I was on board backing Section 936,» Romero Barceló said. «So when I complained publicly that we were supporting the permanence of the tax credit in our party platform, Rosselló accused me of betraying him. He believed Cifuentes instead of me.»

Fast-forward to 2012 and not much has changed, says Romero Barceló, who still sees a Legislature timid in its responsibility for building a tax base through wage credits.

«I don’t see anyone in the Puerto Rico legislative assembly who is focused on that aspect of the economy,» Romero Barceló said. «That is a very important issue still being ignored.»

SERVICES AS A NEW ECONOMIC ENGINE

While manufacturing remains a strong, but smaller, part of the economy, Romero Barceló sees future economic growth in the services industry, which will be helped through efforts on the permitting and energy fronts.

To help in these efforts, the government could provide incentives to cut the costs of operating on the island, but again the former governor cautions against providing too high a tax break for such firms. Recently passed legislation originated by the current administration grants a 4% tax rate to offshore professional firms that set up shop in Puerto Rico.

One of the best ways to bolster professional services, however, is to improve Puerto Rico’s public education system, the former governor said. Today’s youth must be provided the tools they need to insert themselves into this segment.

«Our educational system isn’t working, and it isn’t in tune with today’s needs and realities,» he said. «Students attending the public school system in Puerto Rico receive an average of 92 school days a year; students in China receive approximately 140 school days a year. It is obvious that Chinese students must be receiving much more education in the same number of calendar days.»

Because of contemporary social realities on the island, to be effective the local school system must assume responsibilities in areas that in the past were taken care of by the nuclear family, Romero Barceló said.

«The one-parent household has become the norm in our society. The single parent must be the provider, custodian and teacher, and must accomplish everything done by a two-parent household in the past,» the former governor said. «That parent, after arriving from work, will most probably be exhausted, but nevertheless, that person still has to feed the children, bathe them and provide all the other things children require; in most cases, that person won’t have the energy to sit down and also study with them.

«That being the case, the school system has to ensure that students return home with their assignments already done. That requires additional school hours.»

The school system must also actively participate in helping students understand the concepts of values and good citizenship, he said.

«Another very important aspect that the one-parent household, because of its difficult circumstances, isn’t providing is supervision. Our youth are growing up without it. If no one supervises our children, who is going to teach them values, morals and the concept of good citizenship? These factors are very important ingredients for a healthy society, Romero Barceló said. «If the family can’t provide the needed controls and values to develop a balanced individual who will become a good citizen, then the state has to assume the responsibility through educational programs.»

The local educational curriculum should be revised and refocused to the global markets’ needs, he continued.

Romero noted the service industry provides Puerto Rico great opportunities for economic growth, but good technical education in areas related to it has to be provided by the state. That isn’t happening, he said.

«Regional colleges were initially conceived as two-year technical schools that would educate students to become professionals such as medical assistants, accountants, electricians and plumbers,» he said. «The concept was skewed and eventually they all evolved into four-year schools with most of the students concentrating in humanities, communications and other doctrines that won’t allow them to find meaningful jobs once they graduate because those aren’t necessarily the skills needed in today’s job market.

«It is almost unbelievable that the vast majority of students attending the University of Puerto Rico’s Mayagüez campus, conceived as a school of higher education in technical doctrines such as engineering and agronomy, and that in the past graduated some of the best engineers in the world, are now in courses of study unrelated to these doctrines.

«We need to understand what services Puerto Rico as a country can export, refocus our educational curricula toward doctrines that will allow students to enter those areas, and help them understand that the world is their market.»

BENEFITS UNDER THE U.S. FLAG

Romero Barceló said the extension of the federal minimum wage to Puerto Rico was the biggest act of social justice of the past century. While critics said the move would destroy the economy, the former governor said it helped the working class improve its standard of living and worked to improve local economic conditions.

He also said it would be very difficult and dangerous for Puerto Rico to look for Jones Act exemption by itself rather than in collaboration with the states of Alaska, Hawaii and the other noncontiguous domestic territories.

«It would be almost suicidal if Puerto Rico were exempted from the Jones Act by itself without other states and territories,» Romero Barceló said. «Puerto Rico is too small a market to attract various important foreign-flagged carriers at the same time. Unlike U.S.-flagged companies that dedicate themselves to domestic markets, it is legal for international carriers to form conference groups, which are technically legal monopolies. At these conferences, member companies fix cargo rates and decide who services what market. In Puerto Rico’s case, probably just one of them would control the whole market, and that would allow that company to raise rate levels, having absolute control over them.

«Federal antitrust laws, and the fierce competition among U.S. Jones Act carriers that at present service our market, won’t allow them to do that.»

THE REFERENDUM THIS TIME

Among the more notable episodes of consensus building during Romero Barceló’s tenure as Puerto Rico’s resident commissioner in Congress was his 11th-hour lobbying of Rep. Earl Pomeroy (D.-N.D.), which helped pass the Puerto Rico Status Act of 1998 in the U.S. House of Representatives by one vote. The bill, for Puerto Rico’s self-determination, was the first step in what was to have been a federally mandated status plebiscite that ultimately died in the U.S. Senate.

Now, nearly 20 years later, Puerto Rico will again be holding a status vote after the U.S. Senate failed to mark up HR 2499, which comfortably passed in the House of Representatives with broad bipartisan support.

The measure was to have enabled a two-tier vote taking place on two separate questions, the first of which would have asked whether they wanted Puerto Rico to change its current commonwealth status— yes or no. If the «yes» vote obtained a majority, the second vote would have asked the electorate to choose between: statehood, free association and independence.

Instead of following the U.S. House, the upcoming locally mandated status plebiscite is a departure from HR 2499 in that it asks two questions on the same ballot— whether voters prefer to have Puerto Rico remain in its current status and, in a second question, whether Puerto Rico should choose: statehood, free association or independence.

This represents the possibility of a contradictory outcome, Romero Barceló said.

To avoid such confusion, the former governor has been advocating for amendments to the language of the local bill.

Although some amendments have been made to the bill—the statehood option is now clearer—Romero Barceló believes a contradictory outcome is still possible, which would more likely put Puerto Rico on the comedy shows rather than lead to a change of status.

In place of the proposed vote on status, he suggested a vote that will allow Puerto Rico residents to claim their rights as U.S. citizens. The vast majority of voters who want to retain ties to the U.S. would understand this better than the current vote, and it would send a clearer message to Congress, he said.

«We are doing it from a status point of view, and not from an individual point of view. People understand their rights, not an abstract or a status,» Romero Barceló said. «Congress will do what is easy for them. And it isn’t easy for them to deny U.S. citizens their equal rights.»

John Marino, Philipe Schoene Roura, Carlos Márquez, Jaime Santiago, Alexander López, Eva Lloréns Vélez and Alex Díaz contributed to this report.