Puerto Rico fights tax evasion as it seeks new revenue sources

With recession biting into profits at their chain of burger restaurants and surf shops, two brothers responded in a way Puerto Rico authorities say is common: by shortchanging the government.

Javier and Oscar Juelle failed to turn over $1.27 million in sales taxes they collected over four years, a move their lawyer Joaquin Monserrate said was meant to help keep them afloat on an island where many businesses have failed in recent years.

"It was a way to try and survive," Monserrate said. "They were and are in a tight economic situation and were using the money to pay for other things."

While the brothers were caught and ordered last year to pay the money owed, many others go unpunished, according to officials who say widespread tax evasion by businesses and individuals is one reason the island is in dire financial straits. Economists say Puerto Rico captures just over half the tax revenue it should, failing to collect on an estimated $800 million in unreported income each year.

A new plan backed by Gov. Alejandro Garcia aims to boost revenue and tackle the U.S. territory's spiraling public debt by creating a 16 percent value-added tax, or VAT. If approved, manufacturers would pay the tax on raw materials and include it in the price of the product sold to retailers, who then would pass it on to consumers.

Having the tax levied and recorded at each stage would make it harder for businesses to evade taxes. It also would replace the island's current 7 percent sales tax, approved in 2006, that many people avoid through cash transactions.

"We currently have a tax system that penalizes work and productivity while encouraging evasion," Garcia said. "It is inefficient and unfair."

Advocates say the VAT would boost revenue collection as Puerto Rico struggles to pay off a $73 billion public debt, which leads to higher interest rates and makes it hard for the government to borrow money. Garcia, who faces re-election next year, is likely to win support from the legislature, where his party holds the majority, despite strong public opposition. The proposal currently is being debated, although some lawmakers including the president of the local House of Representatives, are demanding changes.

Garcia was scheduled to make an announcement Monday about the VAT. His chief of staff dismissed speculation the measure would be withdrawn.

The VAT system is used widely in the European Union and elsewhere, but not in the United States. Supporters say it helps boost revenue in financially strapped countries with high unemployment and limited income. Puerto Rico, mired in an 8-year recession, has an unemployment rate of 13 percent, more than twice that of the U.S. mainland.

Business owners in Puerto Rico, however, say it will be costly to implement and will lead to a drop in consumption.

"Our main concern is that it would cause an enormous contraction in the economy, which is already extremely fragile," said Ruben Pinero, president of a local retailers' association.

Puerto Rico's government has addressed those concerns and others through a barrage of TV, radio and newspaper ads, saying a VAT would help end pervasive tax evasion.

According to the Treasury Department, more than 80 percent of self-employed people, including attorneys, claim to earn less than $15,000 a year; 69 percent of sole business proprietors report earnings below $11,000 a year; 37 percent of corporations report losses. And of the more than 1 million tax returns filed, only 12,000 people on the island of 3.65 million claim to make more than $150,000 a year.

"Tax evasion is massive," said government prosecutor Alberto Valcarcel, who oversees such cases. "When you see the number of gated communities, of marinas, of the cars they own, obviously it's more than what they claim."

The 2014 prosecution of the Juelle brothers is the biggest case so far to be prosecuted in a new crackdown on tax evasion. The brothers closed several of their businesses, leaving open only one Bora Bora surf store and and about five Flamers restaurants.

"They were caught at a crucial moment and used as a warning to other business owners," Monserrate said.

Not counting illegal ventures such as drug trafficking, Puerto Rico's underground economy is estimated to be worth $16 billion, about one-quarter of total gross national product, compared to the estimated 13 percent to 19 percent in the U.S. proper.

Even many medical and legal professionals accept only cash payments, while some businesses, including restaurants that frequently are crowded with diners, report suspiciously low earnings or losses, said economist Jose Villamil, a former U.N. consultant and CEO of an economic and planning consulting firm.

Puerto Rico has stepped up prosecution of tax evaders in recent years, hiring 150 auditors and investing $350,000 in new technology. But the VAT is a more powerful tool, said Treasury Secretary Juan Zaragoza, because it makes record-keeping largely unavoidable.

He said it makes financial sense to apply it in an island where, despite its troubled economy, people love to shop.

"I can activate the National Guard and go after all these people, but the question is whether that's the most efficient and effective way of doing it," he said. "At the end of the day, all these people, what do they do with their money? They spend it."

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Danica Coto on Twitter: www.twitter.com/danicacoto