By Howard Hills

Ready for Transition to Uniform Taxation

In all 32 territories that became states, federal and local laws unique to each territory’s historical relations with Washington had to be conformed to the domestic national law applicable to states. Transition to the uniformity of national law was a necessary step in the transition to statehood as a fully domestic legal and political status.

Only the territory of the Philippines and three small Pacific Island chains governed by the U.S. under a U.N. trusteeship were converted from the administration as territories to non-domestic status as a step to nationhood. For the non-U.S. citizens of the Philippines, the “commonwealth” regime of territorial government under a local constitution was a step toward independence, whereas for the U.S. citizens of Puerto Rico and the Northern Mariana Islands “commonwealth” is a step toward domestic law status.

Deliberations in Washington DC over federal tax reform legislation present Congress with some of the very domestic law issues that must be addressed in Puerto Rico to transition from territorial status to statehood. Congress is compelled to address Puerto Rico’s future status given the fiscal collapse of the debt-devastated “commonwealth” regime of territorial government before a devastating hurricane impact. Tax reform in the case of Puerto Rico must give direction to the island’s future social, political and economic recovery and development.

Congress needs to establish a federal tax policy for Puerto Rico consistent with a transition from all non-domestic features of territory status to a fully domestic model consistent with eventual statehood. At issue are the fiscal mechanics and political dynamics of transition from tax policy and practices that perpetuate Puerto Rico’s status as a dependent federal territorial reservation.

If new tax treatment consistent with integration on equal footing in the national fiscal and economic partnership of states is to be adopted, the time is now before tens of billions are invested in island recovery. Only a federal policy promoting permanent union and eventual statehood will mobilize private capital needed to make possible recovery and reconstruction to attain a standard of living better than territorial status permitted.

Puerto Rico Congressional Representative and Legislature Speaker Lead Way

Puerto Rico’s non-voting member of Congress, Jennifer Gonzales Colon, as well as Carlos “Johnny” Mendez, Speaker of the House of Representatives of Puerto Rico, have provided bold leadership in consultations with Washington on the impact in Puerto Rico of tax reform legislation pending in Congress. Both are calling for Congress to end federal tax policies that treat Puerto Rico as a foreign jurisdiction for some tax purposes, even as Congress treats Puerto Rico under federal law “like a state” for most other purposes.

Like Gonzales Colon, Speaker Mendez wants to begin by ending foreign tax shelters for U.S. companies that have a presence in Puerto Rico, and bringing tax sheltered deposits in off-shore foreign accounts back to the United States, including Puerto Rico. He would like to see companies that sent profits earned in Puerto Rico to overseas tax havens created by Congress bring that capital back and put it to work in Puerto Rico.

But the first step is to treat Puerto Rico as a domestic not foreign jurisdiction for all purposes, including taxation. Mendez recognizes there is fear in Puerto Rico about application of federal income tax even before statehood. But he reminds his constituents only those who would pay if they lived in a state now will pay in Puerto Rico, and those whose income is below taxable level will not.

Domestic status tax policies and state-like treatment while still a territory would enable U.S. citizens to become familiar with filing federal tax returns consistent with uniformity of law in states, even if no taxes are owed. On this issue his views differ from current Puerto Rico Governor Rossello Navares, who rejects federal taxation before statehood as “the height of colonialism.”

However, the current failed “commonwealth” regime is actually the height of colonialism. The local government actually collects local income taxes on as mandated by and on behalf of Congress to pay for the cost of federal and local government in the territory. The local government is really a surrogate for the federal government, not a fully democratic or sovereign government like a state that acts in its own name and right in fiscal matters.

In addition, as a territory Puerto Rico already pays over $3 billion annually in federal payroll taxes for Social Security and Medicare. That’s in addition to federal income tax on all earnings from the 50 states or international overseas sources. Clearly, the “no taxation without representation” slogan during the American Revolution was never incorporated into the U.S. Constitution.

Any person under U.S. jurisdiction can be made to pay taxes. But only states have representation and equal rights to participate in consent of the governed in the enactment of federal tax laws.

Understanding Federal Taxation History

In the 65 years since the “commonwealth” regime of territorial government was created by Congress, federal fiscal and taxation policy has been manipulated by anti-statehood factions to create fiscal and economic barriers impeding the transition to statehood. In the name of “autonomy” and “jobs” the anti-statehood autonomist party in Puerto Rico was successful in convincing Congress to treat Puerto Rico as a foreign jurisdiction tax shelter.

However, tax savings by U.S. corporations in the territory were disproportionate to benefits to the local economy. Yet, at the same time dependence on presence of corporations benefitting from those tax shelters was preventing balanced social, political and economic development. Congress phased out the federal tax shelters and imposed military base closings that combined to produce economic contraction, leading excess local government borrowing that eventually bankrupted the “commonwealth” regime.

At the same time the “commonwealth” was treated “like a foreign country” for fiscal and tax policy purposes. In many other ways as a territory Puerto Rico was treated more and more “like a state.” For purposes of federal-territorial relations, self-government, commerce, business, education, integration of local and federal judicial rulings, and citizenship rights under the Constitution, Puerto Rico has been more like a fully domestic state than a territory for decades.

As a result Puerto Rico is more fully integrated into the social, political, legal and economic life of the nation than most if not all of the 32 territories that became states. In fact, Puerto Rico is the last large and populous territory with birthright U.S. citizenship (Population: 3.5 million) that has not been fully incorporated under the U.S. Constitution and admitted to the union as a state.

One exception to the de facto incorporation of Puerto Rico was the federal tax shelter scam. Related anachronistic federal court rulings made equal and uniform application of the U.S. Constitution and federal law optional and discretionary for Congress. Instead of uniform taxation, for example, federal taxation of local income and federal administration of local civil affairs was delegated to the “commonwealth” regime of territorial government.

Some past and current federal tax policies treat Puerto Rico as a foreign jurisdiction where U.S. companies can maintain tax shelters for profits earned in the territory. This treatment of a U.S. territory as a foreign colony where taxes on profits can be deferred was made possible primarily by old investment incentives that were phased out under a 1996 act of Congress.

Local territorial fiscal and tax policy as well as budget practices in Puerto Rico are still structured to accommodate the existence of sheltered off-shore profits. But the tax reform legislation Congress appears likely to pass recognizes that the off-shore tax havens need to be ended since the tax sparing incentives for companies to invest in Puerto Rico have been phased out for more than a decade.

Howard Hills is author of Citizens Without A State and former counsel for territorial affairs in the Executive Office of the President and National Security Council.