A plebiscite vote scheduled on November 5th, the day of the Puerto Rican general election, will provide voters with a choice between two options for a more democratic governing arrangement in the most populous U.S. territory: statehood or independence. Independence with a U.S.-Puerto Rico treaty known as a Compact of Free Association is listed separately as a third choice.
In a recent poll of Puerto Rico voters, 73% chose statehood over independence. Asked about the benefits and drawbacks of statehood, however, 21% of respondents worried that they would pay higher taxes as residents of a state.
How realistic is this fear?
The Earned Income Tax Credit: Tax Refunds for Working Families
Most people who live in Puerto Rico do not have to pay federal tax on their income, but Puerto Ricans also don’t have full access to a federal tax benefit for working families called the Earned Income Tax Credit (EITC). The EITC is a refundable tax credit, meaning that if you owe less in taxes than the value of the credit, the U.S. government will refund the rest to you. The government essentially cuts a check to the taxpayer.
In states, the EITC is so generous that many workers end up not owing any U.S. taxes at all. Many get money back from the U.S. government when they file their taxes.
The average annual income in Puerto Rico is $24,000. Most people earning $24,000 in the states can expect to owe about $3,000 in federal income tax before credits. In states, however, families with two children in 2024 can expect to receive almost $7,000 by claiming the Earned Income Tax Credit. After they cover their three thousand dollar tax liability, they end up receiving the remaining roughly $4,000 from the U.S. government.
It is possible, and even likely, that the average Puerto Rican would actually pay less in taxes – and probably get an annual check from the U.S. Internal Revenue Service – if Puerto Rico were to become a state. Any increase in worker tax liability would be offset by the U.S. Earned Income Tax Credit.
Independence Threatens $1 billion Puerto Rican EITC
In 2021, Congress passed a law that provided up to $600 million a year to Puerto Rico to be shared among working families through a special EITC policy tailored for Puerto Rico. While not as generous as the EITC the U.S. government provides to states, the Puerto Rico EITC is substantial.
The 2021 federal law, called the American Rescue Plan, incentivized an expansion of Puerto Rico’s local Earned Income Tax Credit (EITC) and permanently increased federal EITC payments to Puerto Rico by providing a three dollar federal match for each dollar allocated by the Puerto Rican government for EITC up to the $600 million limit.
Puerto Rico’s local EITC distributes up to $200 million/year to working families, although according to a report by Espacios Abiertos, the credits fell well short of this maximum in 2019 and 2020 when payments were only $117.5 million and $109.6 million respectively. The 2021 law incentivizes the full payment of the local $200 million/year EITC by providing the three-to-one federal match up to $600 million.
According to the Espacios Abiertos report, $1.061 billion was provided to working families in Puerto Rico after the 2021 law passed through the newly expanded EITC. The U.S. payments would be expected to end – possibly abruptly – under either independence scenario (including with Free Association), but would be enhanced under statehood as EITC payments to working families living in states are significantly higher than payments to families in Puerto Rico.
Under statehood, with full integration into the U.S. tax code, the average Puerto Rican will not pay income tax, but will instead get money back. All they would have to do is file a federal income tax return. Families in Puerto Rico already file federal income tax forms to receive U.S. Child Tax Credits, valued up to $2,000/year per child – another tax benefit for Puerto Rican working families which would be lost if Puerto Rico were to become independent.
