MuniLand

The Puerto Rico corporate tax question

The Government Accountability Office published a report estimating the economic advantages and costs Puerto Rico would have if it enters statehood. The biggest cost would be that Puerto Rico citizens would be required to pay federal income tax on their domestic earnings. Currently they pay federal income tax on income they earn outside of Puerto Rico.

The GAO estimates that If Puerto Rico had been a state in 2010, the estimated income tax paid by individual taxpayers would have ranged from $ 2.2 to $ 2.3 billion. The report also estimates changes in federal entitlement benefits that would flow to the island. In many cases there would be additional federal funds for the island.

The critical piece of the puzzle would be the change in income taxes for Puerto Rico corporations and subsidiaries of U.S. corporations that do business on the island. These corporations are a big contributor to Puerto Rico general fund revenues. Puerto Rico corporations are currently treated as foreign corporations under U.S. tax law. Here is what the report says (page 115):

Now, here is where Microsoft comes in:

Based in Humacao, Puerto Rico, Microsoft Operations Puerto Rico (MOPR) is responsible for producing all optical media sold by Microsoft in the Americas. This fast-growing complex has a complement of 250 employees and produces 250,000 disks a day.

El Nuevodia lays out what this means:

In 2012, the Senate Chairman of the Subcommittee on Investigations, Democrat Carl Levin (Michigan), presented a report stating that between 2009 and 2011, Microsoft was able to keep out of the hands of the U.S. Treasury about $21 billion by transferring certain property rights to their intellectual subsidiary in Puerto Rico.

Taxing the buzz

Colorado voters approved recreational marijuana sales last November. The infrastructure is now being prepared to begin sales on January 1, 2014. Part of the plan approved by voters is a state tax of 25 percent. Reuters reports:

Under the marijuana tax proposal, a combined 15 percent excise and 10 percent sales tax would be imposed on recreational pot sales, with the first $40 million raised to fund school construction projects.

In Denver, a local ballot measure that would tack an additional 3.5 percent city sales tax on pot shops also appeared headed for passage, by a margin of 69 to 31 percent with roughly a third of votes counted.

Is this an orderly process of tax reform?

Although there are people, like Bond Dealers of America CEO Mike Nicholas, who have predicted that federal tax reform will not happen until 2017, the Senate Finance Committee has kick-started the process. Law firm KL Gates sent out a primer about the Senate Finance Committee plans:

The momentum toward comprehensive tax reform accelerated significantly on June 27th, 2013, when the bipartisan leaders of the Senate Finance Committee, Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT), sent their Senate colleagues a joint letter requesting Senators to submit their tax reform proposals by July 26th, 2013. [1] In doing so, Senators Baucus and Hatch are beginning to set the table for the Finance Committee to consider tax reform in the coming months. As discussed in our previous alert, the time to weigh in on tax reform is now.

Senate Finance Committee members Senators Max Baucus and Orrin Hatch have asked all senators for their tax reform wish lists:

The myths around the municipal bond tax exemption

The debate surrounding the sacred cow of municipal bond tax exemption is reaching new heights. In a recent report from the National League of Cities, estimates by SIFMA (the dealer trade group) show that municipal governments would have paid an additional $173 billion in interest over 10 years with a 28 percent cap on municipal bond tax exemption. And if Congress had fully repealed the municipal bond tax exemption, municipal issuers would have paid an additional $495 billion in interest costs over the last 10 years. These amounts would be on top of the $1.09 trillion in interest paid on municipal bonds in the last 10 years under the current law.

SIFMA/NCL arrived at these projections using this method (page 6-7) emphasis mine:

The information in Chart C was determined by taking the amount of interest paid by each jurisdiction in the last fiscal year, with a median interest average of 4.69 percent over the past 15 years (Thomson Reuters), and applying a 70 BPS increase for what the interest costs would have been if the bonds were issued with a cap in place, and applying a 200 BPS increase for what the interest costs would have been if the bonds were issued without the exemption in place.

Will Puerto Rico’s governor part ways with Grover Norquist?

Last month, Puerto Rico Governor Luis Fortuño delivered a speech at the libertarian Reason Foundation on “how Puerto Rico avoided becoming “America’s Greece.” In his talk, the governor espoused the anti-government ethos of Grover Norquist, whom he cited as a friend in the first minute of his remarks. Fortuño has been a staunch advocate of “right-sizing” government: Soon after taking office, he laid off a substantial number of the commonwealth’s employees and reduced the island’s personal, corporate and property taxes.

Despite these cuts, Puerto Rico’s budget is still unbalanced. Fortuño has been relying on bond issuance through COFINA, the government’s off-balance-sheet, special-purpose vehicle, to make up for annual shortfalls to his budget.

Now, Republicans in Congress are working to blow another hole in Fortuño’s budget. As part of their effort to stave off the impending, automatic cuts to the defense budget, House Republicans passed legislation that kills a special provision of the Affordable Care Act increasing Medicaid grants to Puerto Rico. Faced with the threat of losing billions of dollars in federal payments each year, Fortuño now seems to think that lower federal spending is not that appealing. He pushed back on these cuts in an op-ed on CNN.com:

A smarter way for Congress to talk about muni tax code

Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets, sent around a comment note suggesting that the media coverage of the Senate Finance Committee hearing Wednesday that included discussion of possible changes to the taxation of municipal bonds was overheated:

Yesterday, the Senate Finance Committee held a hearing entitled “Tax Reform: What It Means for State and Local Tax and Fiscal Policy”. A simple reading of the media accounts of this hearing would lead one to believe that the entire event was dedicated to a detailed discussion of the future of the tax-exempt status of municipal bond interest. So we decided to review the tape of the hearing in order to see what in fact was discussed. In reality, the vast majority of the hearing was focused on two issues – the deductibility of state and local taxes by federal taxpayers and the ability of state and local governments to collect sales taxes on internet and catalog purchases.

Both Committee Chairman Max Baucus and Ranking Member Orrin Hatch made some passing comments about tax-exempt bonds and the federally subsidized taxable Build America Bond (BABs) program, with Baucus making generally positive statements about BABs and Hatch making generally negative ones. Senator Maria Cantwell of Washington State expressed some concern about the importance of tax-exempt bond financing to public power utilities in the northwest, but beyond that, there wasn’t a whole lot of discussion about the muni tax exemption.

The state of state and local taxes

In addition to federal taxes, Americans are responsible for paying state and local sales, personal income and property taxes, and a variety of fees for the use of their cars, sewer systems and water systems. Although approximately 47 percent of the population pays no federal income tax, those people do contribute to public safety, education and welfare through their state and local taxes (and, it should be noted, also pay federal payroll taxes). Across the nation, sales taxes bring in about one-third of state revenues, personal income tax revenues bring in another third, and a variety of other taxes and fees make up the balance.

Rarely do you hear cries from the citizenry to have their taxes raised – usually you hear people lament that rates are too high. A recent Bloomberg slideshow listed aggregate tax rates by state but used data that did not include local tax rates. Many of the 1,256 comments on the slideshow pointed out that the information was wrong. In almost every comment that I read, people thought that their taxes were too high.

The response of state governments to their citizens’ cries for lower taxes has been ambivalent. While states decreased their sales taxes by $5.2 billion for 2012, they also increased personal income taxes by $3 billion, according to a National Conference of State Legislatures poll. There is a lot of variance among states in sales tax rates, though: Five states collect no state sales tax, and 13 states have an average local sales tax rate of zero. State and local governments are looking for additional revenue from every available source, but I predict that we will mainly see increases in income taxes for higher earners rather than increases to sales tax rates.

Pennsylvania to forgo $24 billion in fracking royalties

There are shale gas fields covering more than half of the United States, but Pennsylvania has emerged as the rising star of domestic energy production with its “Mighty Marcellus” fields. This is a great resource for Pennsylvania, but I’ve been confused about legislation that would impose an “impact fee” on shale gas producers instead of the traditional volume-based royalty structure used by other states. The loss of revenues to the state over the next 20 years using the “impact fee” could be approximately $24 billion using current gas prices. If gas prices doubled (they are currently at 10-year lows), losses to the state could exceed $48 billion or more.

The energy states of North Dakota, Wyoming, Texas and Oklahoma historically have earned substantial revenues from energy royalties. It seemed odd that Tom Corbett, the Pennsylvania governor who received substantial campaign contributions from gas producers, barred his shale gas commission from even considering a royalty or gas tax.

When energy producers do cost-benefit analyses, they use very sophisticated modeling in which the primary input is the quantity of “recoverable” oil or gas in an area. The second input is the projected demand and supply for energy, which in turn determines its price. Finally, the modelers factor in business expenses, primarily the depth of well drilling required and the cost to haul the energy to a pipeline terminus or railroad depot. In the case of natural gas they might include the cost to liquefy the gas for easier transport. Generally at the end of all the calculations they look at the cost of paying mineral rights fees to landholders and royalty fees to the state. All these inputs move around constantly, and projecting them years or decades ahead requires quantitative wizardry.

When home prices and property taxes diverge

The latest S&P/Case-Shiller Home Price Index, released yesterday, wasn’t pretty. Housing values continued to fall, their 5th consecutive year-on-year decline. (You can download the data here). The Federal Reserve Bank of Cleveland had this to say about the release:

According to today’s [Case-Shiller] report, the fourth quarter started with broad-based declines in home prices… On an annual basis, the 10-city composite is down 3 percent and the 20-city composite is down 3.4 percent, and eighteen of the 20 MSAs are also in negative territory.

Basically, there’s blood on the streets everywhere.

The Federal Reserve Board reports in its Flow of Funds data (line 4) that the value of household real-estate assets has declined from $22.7 trillion in 2006 to $16.1 trillion in the third quarter of 2011. That’s a loss of 30 percents. Have revenues from property taxes, which are supposed to reflect the property valuations, mirrored the same decline?

Who carries the heavier tax burden: corporations or people?

Ever wonder whether people or corporations carry a heavier tax burden? Well, it’s not even close: people pay more in taxes by a long shot.

First, let’s look at federal tax statistics. In 2008, corporations paid 12.0 percent of federal revenues; the figure for individuals was 45.3 percent. Similarly, total corporate income tax after credits came in at $200 billion in 2008, while total individual federal income tax over the same period was $1.145 billion.

Now let’s look at state tax stats. In 2008 corporations paid 4.27 percent of state and local revenues; over the same period individuals paid 27.9 percent of state revenues. Similarly, state corporate income taxes came in at $52 billion while state personal income taxes came in at $301 billion and state sales taxes came in at $ 278 billion.

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