Former Gov. Aníbal Acevedo Vilá does not mince words when reflecting on the creation of Puerto Rico’s sales and use tax (IVU in Spanish). “Approving the IVU was a mistake,” he said, recalling the political and fiscal pressures that shaped the 2006 reform.
At the time, Acevedo Vilá of the Popular Democratic Party (PDP) had to deal with a Legislature controlled by the New Progressive Party (NPP). He said he opposed the measure but accepted it because it was the proposal advanced by then‑House Speaker José Aponte. “The tax reform approved under my administration was José Aponte’s bill. I never presented a reform of my own. He had a 7% IVU, and I accepted it,” he said.
Economists and advisers insisted the IVU would eliminate the cascading effect of the old “arbitrio” at the docks, reduce evasion and stabilize government revenues, Acevedo Vilá said. But within two years, he concluded the opposite was true. “It was not producing the money they promised. It had a negative psychological effect on consumers, and evasion was a serious problem.”
In his final State of the Commonwealth address, he proposed returning to the previous system in which taxes on goods were collected at the docks, but the NPP-controlled Legislature rejected the idea. He noted that his first budget did not include a sales tax at all; instead, it eliminated the dozens of exemptions that had hollowed out the old excise tax. “That produced about $500 million. But the Legislature rejected it because they wanted a sales tax,” he said.
Two decades later, the IVU has become one of the most consequential — and controversial — components of Puerto Rico’s tax architecture. Treasury Department data show that since 2006, Puerto Ricans have paid close to $50 billion in sales and use taxes, including almost $10 billion in just the past three years.
What was once sold as a modernizing reform has become, in the words of CPA and attorney Carlos Serrano, “‘una melcocha’ — a sticky, tangled mess of overlapping rules, political compromises and structural contradictions.”
Serrano, who helped design the IVU while serving as Assistant Secretary of Internal Revenues, remembers the conditions that led to the IVU’s creation. The “arbitrio general” (excise tax) — a tax collected at the ports — had collapsed under the weight of more than 30 exemptions, inconsistent enforcement and rampant evasion. “What was happening at the docks was horrible,” he said. “Shipping containers marked as orange juice were full of cooking oil. Children’s clothing was used as a loophole for everything. The system was impossible to administer.” Despite fluctuations in imports, collections remained stuck around $500 to $600 million a year.
In 2004, the CPA Foundation published a study comparing a U.S.-style sales tax with a European-style value-added tax (VAT). Economists favored the VAT for its transparency and self-enforcing structure. But politics intervened. At the time, the PDP held the governorship, while the NPP controlled the Legislature. The phrase “‘IVA, IVA y no va’” — attributed to former NPP Gov. Pedro Rosselló — captured the resistance to adopting a tax perceived as “too European.” The result was a compromise: a sales and use tax modeled loosely on U.S. systems, but implemented in a way that diverged from best practices.
The IVU was enacted through Law 117 of 2006, the so‑called Justice Tax Act. It replaced the “arbitrio” with 7% sales and use tax, divided between the central government (5.5%) and municipalities (1.5%). The design included exemptions for resale and a business‑to‑business (B2B) exclusion intended to prevent cascading taxation. The implementation date — November 15, 2006 — was chosen to capture revenues from the Christmas holiday shopping.
One Measure of Success
The IVU did succeed in one major respect: it dramatically expanded collections by capturing consumption from the underground economy. “People who painted houses on weekends or worked informally were not paying income tax,” said David Rodríguez, president of the Puerto Rico Association of Certified Public Accountants. “But when they bought prepared food, clothing or supplies, they paid the IVU.” Collections have surged from roughly $600 million under the old excise tax system to more than $3 billion today.
But the system quickly drifted from its original design. The government used IVU revenues to back COFINA bonds during the 2006 shutdown, tying a significant portion of the tax to debt repayment. “A big part of what we pay goes to COFINA,” Acevedo Vilá said. “That limits what you can do.” Today, about $500 million of IVU revenue is automatically diverted to COFINA under the island’s debt restructuring agreements.
As the IVU became more central to Puerto Rico’s finances, the broader tax system around it grew increasingly distorted. The Financial Oversight and Management Board — which declined to comment for this story — has repeatedly warned in its fiscal plans that Puerto Rico’s tax structure is “complex and opaque,” riddled with deductions, exemptions, credits, special rates and private tax decrees that benefit narrow groups while narrowing the tax base.
The Board argues that Act 60’s preferential rates for dividends, capital gains, physicians and targeted industries create inequities and high transaction costs, while negotiated tax decrees lack transparency and lock in benefits for years, making reform difficult. It also notes that Puerto Rico’s sales and use tax, now at 11.5%, is among the highest in the United States, yet riddled with exemptions that distort consumption and may depress revenue.
The Board insists that any tax reform must eliminate incentives with negative returns, impose annual limits on those that remain, and evaluate expiring decrees as potential funding sources for broader reforms, including general rate reductions.
A ‘Fragmented’ and ‘Unmanageable’ System
Serrano argues that the IVU itself has become a reflection of this broader structural complexity and incoherence. “Today, the IVU is a fragmented system,” he said. “There are 79 municipal jurisdictions with their own rules, a hybrid state IVU that doesn’t credit everything, a poorly implemented quasi‑VAT, and a remote‑seller regime based on U.S. jurisprudence that doesn’t hold water here.”
He noted that during Puerto Rico’s fiscal crisis, the government attempted to adopt a 16% VAT that would have significantly reduced income taxes, but the proposal required merchants to prepay VAT liabilities — something Serrano calls “absurd.” The opposition was immediate. The VAT never passed. Instead, the Legislature raised the IVU to 11.5%, reinstated collection at the docks, and imposed the B2B tax, reintroducing the cascading effect the IVU was originally designed to eliminate.
Rodríguez agrees that 20 years later, the system has become unmanageable. “There are more than 130 exemptions and preferential rates,” he said. “Every exemption increases compliance costs and makes enforcement harder.”
He also argued that while the IVU has become a major revenue source, it is also deeply regressive. The government has attempted to offset this through the refundable Earned Income Tax Credit, which now returns more than $1.4 billion annually to low-income workers.
Private Sector Coalition Clamors for Tax Reform
Rodríguez is leading a coalition — including the Chamber of Commerce, Manufacturers Association and United Retailers Association — pushing for a comprehensive tax reform. Their proposal includes a flat 4% tax rate for individuals and corporations, 0% on passive income, and a simplified IVU with no exemptions. To address regressivity, the plan includes a monthly debit card that would refund IVU paid by low-income households. “If someone buys milk, they get the IVU back,” Rodríguez said. “But if someone buys 10 lobsters and 10 bottles of champagne, they pay the tax. That’s fairness.”
The coalition has already met with the governor, Treasury secretary, Tax Foundation, U.S. Chamber of Commerce, and Cato Institute. They are now modeling the fiscal impact of the proposed tax reform with Treasury and preparing to present the reform to the legislature and the Oversight Board. Chamber of Commerce President José “Che” Julio Aparicio Laspina said the goal is to file the reform “no later than September,” adding that the groups are coordinating to avoid fragmentation. “We want everyone aligned so the effort doesn’t collapse,” he said.
But political skepticism remains. Senate Minority Leader Luis Javier Hernández Ortiz said he has seen “no movement” in the Legislature to address tax reform. “It was supposed to be integrated into this budget, but it wasn’t,” he said. “The Oversight Board has already said no tax reform will be considered separately from the budget. They should have kept their word.” PDP President Pablo José Hernández said he would like see a lower IVU in any tax reform.
Skeel Speaks Out
Former Oversight Board chairman David Skeel said the fundamental obstacle to tax reform in Puerto Rico is the political cost of taking anything away from groups that currently benefit from the system. “The tax system is very complicated. Anything you change is likely to take away benefits from somebody who’s currently getting them. And they push back really hard,” he said.
For Skeel, this dynamic explains why Puerto Rico has repeatedly failed to execute a comprehensive overhaul. He noted that the Board has long urged the government to avoid piecemeal adjustments and instead “seriously rethink the whole” structure — a full redesign rather than incremental fixes that preserve the system’s contradictions.
Skeel also cautioned that any discussion of reducing or restructuring the sales and use tax must confront both its regressivity and reliability. He acknowledged that the IVU can have a distortionary and regressive effect, but emphasized that its greatest advantage is that it actually gets collected.
“It’s not obvious to me that getting rid of the sales tax in the short run is something Puerto Rico wants to do because it is a tax that actually gets collected,” he said. With COFINA commitments tied directly to IVU revenues, Skeel warned that lowering the rate would require careful modeling and a clear plan to
preserve fiscal stability.
Acevedo Vilá, reflecting on the IVU’s legacy, said the tax never delivered the fiscal stability promised. “The premise didn’t materialize. Ten years later, we went bankrupt,” he said, but failed to mention the government’s mismanagement of its finances, including borrowing millions of dollars without clear sources of repayment.
Regardless of past actions by various government administrations, he warned that today, Puerto Rico faces uncertainty once federal disaster funds run out. “Thinking we’re in a growing economy is dangerous,” he said.
Twenty years after its creation, the IVU remains both indispensable and deeply flawed — a tax that expanded collections but entrenched structural contradictions. It is the Island’s largest source of revenue, yet also one of its biggest obstacles to a coherent tax system.
As Rodríguez put it, “Puerto Rico has never done a comprehensive tax reform. If we want competitiveness, investment, and growth, we need one now.”
Whether the Island can untangle the “melcocha” — or whether political inertia will preserve it for another decade — remains an open question.
