A plebiscite slated for November 5th, coinciding with the Puerto Rican general election, will present voters with two alternatives for establishing a more democratic governance structure in the largest U.S. territory: statehood or independence. Additionally, independence through a U.S.-Puerto Rico agreement referred to as a Compact of Free Association is offered as a third option.
In a recent survey of Puerto Rican voters, 73% favored statehood over independence. However, when inquired about the pros and cons of statehood, 21% expressed concerns about potentially higher taxes as state residents.
How legitimate is this concern?
The Earned Income Tax Credit: Tax Refunds for Working Families
Most residents of Puerto Rico are exempt from federal income taxes, but they also lack complete access to a federal tax initiative for working families known as the Earned Income Tax Credit (EITC). The EITC is a refundable tax credit, which implies that if your tax liability is less than the credit amount, the U.S. government will reimburse you the difference. Essentially, the government issues a refund check to the taxpayer.
In the states, the EITC is so beneficial that numerous workers find themselves owing no federal taxes at all. Many even receive refunds from the U.S. government upon filing their tax returns.
The typical annual income in Puerto Rico is $24,000. Most individuals earning $24,000 in the states can anticipate a federal income tax obligation of approximately $3,000 before credits. In contrast, families with two children in the states in 2024 can expect nearly $7,000 in refunds by claiming the Earned Income Tax Credit. After settling their $3,000 tax liability, they receive around $4,000 back from the U.S. government.
It is conceivable, and quite probable, that the average Puerto Rican would ultimately pay lower taxes—and possibly receive an annual payment from the U.S. Internal Revenue Service—if Puerto Rico were to join as a state. Any rise in worker tax responsibility would be mitigated by the U.S. Earned Income Tax Credit.
Independence Endangers $1 Billion Puerto Rican EITC
In 2021, Congress enacted legislation that allocated up to $600 million annually to Puerto Rico to benefit working families through a specific EITC program designed for Puerto Rico. Although not as generous as the EITC available in the states, the Puerto Rico EITC is significant.
The 2021 federal legislation, known as the American Rescue Plan, prompted an enhancement of Puerto Rico’s local Earned Income Tax Credit (EITC) and permanently boosted federal EITC contributions to Puerto Rico by offering a three-dollar match for every dollar the Puerto Rican government allocates to the EITC, up to a limit of $600 million.
Puerto Rico’s local EITC distributes as much as $200 million annually to working families, although a report from Espacios Abiertos indicated that the credits fell considerably short of this ceiling in 2019 and 2020, with distributions at only $117.5 million and $109.6 million, respectively. The 2021 legislation encourages the complete allocation of the local $200 million per year EITC by providing the three-to-one federal match up to $600 million.
Per the Espacios Abiertos report, $1.061 billion was funneled to working families in Puerto Rico following the passage of the 2021 legislation through the newly broadened EITC. Expectations are that U.S. payments would cease—potentially suddenly—under any independence situations (including Free Association), but would be enhanced under statehood, as EITC payments to working families in states are significantly more substantial than those issued to families in Puerto Rico.
Under statehood, integrating fully into the U.S. tax system, the average Puerto Rican would not pay income tax and would receive refunds instead. All they would need to do is file a federal income tax return. Families in Puerto Rico already file federal tax documentation to access U.S. Child Tax Credits, worth up to $2,000 annually per child—another tax benefit for working families in Puerto Rico that would be forfeited if Puerto Rico gains independence.
Puerto Rico and Federal Income Tax
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