Formal Economy, Legal, Money

Puerto Rico's formal economy has been hindered by the coronavirus (COVID-19) while informal activity has skyrocketed, which has led to productivity that could lessen the pandemic's estimated $12 billion impact on the local economy.

Economist Joaquín Villamil explained to THE WEEKLY JOURNAL that when formal economy drops, informal economy flourishes and could muffle that impact. However, he underscored that, in the long term, the situation could pose a dire risk for the government because informal economy is not taxed, which would represent less contributions to the treasury.

Villamil said that prior to the pandemic underground economic activity generated over $17 billion approximately—including $5 billion linked to drug trafficking—or 30 percent of the Gross Domestic Product (GDP). The economist clarified that the number could have been reduced, but it will take off.

"This activity is expected to continue increasing due to job losses. Once the pandemic crisis passes, there will be even fewer jobs than those that have already been lost. Therefore, the need for people to engage in informal activities will be generated. It cannot be said that it is something temporary," Villamil affirmed.

The economist, who is the CEO of the firm Estudios Técnicos, argued that more than 27 cents of every dollar that enters the local economy comes from informal activities. Although this money is not taxed before the Department of the Treasury, also known as Hacienda, it enters the government coffers through the Sales and Use Tax (IVU by its Spanish acronym).

Regardless, various studies maintain that if the government manages to establish a tax policy that includes underground activity and is 50 percent efficient, Hacienda could add nearly $2 billion annually to the treasury. However, Villamil considers it complicated.

Meanwhile, economist José Alameda previously told THE WEEKLY JOURNAL that underground activity monopolizes most of the economies of the poorest countries. In Puerto Rico, just under 50 percent of the population lives under levels of poverty, being the second poorest jurisdiction among 100 countries.

"Formal economy falls and gives way to an increase in unemployment. People— seeking to increase or recover their income—perform non-taxable jobs. Puerto Rico continues to be a poor economy and continues to impoverish. Although it has never been accepted, the informal economy supports a large part of the island," Alameda said.

Likewise, Juan Sosa Varela, dean of the School of Business at the Ana G. Méndez University, argued that informal economy has always been part of the local economy and that, for years, it has contributed greatly to local production.

"A country prospers because it is productive. Productivity may be legal or illegal and doesn't cease to be productivity. As long as this happens, there is a greater chance of an economic recovery. It is better for a person to work in something productive and for that money to be integrated into the formal economy," Sosa Varela said.

The dean also stressed that although prior to the COVID-19 pandemic informal activities were mostly registered in rural areas, given the increase in unemployment, they are now commonplace island-wide.

"There is a misconception that the informal economy is only related to illegal activities. There have been people who have been unemployed and have moved to make masks. They buy the materials from a formal business and pay the IVU for that. The informal money they generate enters the formal economy. Formal or informal, the economy is moving," Sosa Varela said.

Moreover, economist Santos Negrón explained to your correspondent that both economies are tightly intertwined, so any drop in either of them would affect the other.

"They both walk in the same direction because they both sell products and provide services. If one is affected, the other sees a decrease in consumption. In this extreme situation, everyone falls. As the income base of the formal sector weakens, it spreads to the informal sector and vice versa. A cycle of decreasing spending is created," he stated.

Negrón added that the average sales and consumption on the island do not match the 3.2 million inhabitants and the income per capita.

"Consumption is better measured than income that can be informal. When people move to the formal market, income from informal sources is captured and reported through consumption," he said.

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