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Revised Puerto Rico tax law triggers boom in new car sales
Ward's Automotive International / July 1, 1995

By Larry Luxner

SAN JUAN, Puerto Rico -- Detroit automakers looking for overseas growth need look no further than Puerto Rico, where U.S. auto sales are once again booming -- thanks to the recent overhaul of a 1970s-era tax law that encouraged energy conservation at the expense of heavier, more powerful American automobiles.

More than 1.2 million registered vehicles now choke the streets and highways of Puerto Rico, a mountainous, tropical island that accounts for only 10% of the population of the Caribbean, yet consumes half the region's gasoline.

As a U.S. Commonwealth, Puerto Rico enjoys a relatively high standard of living, made possible largely through federal welfare programs, unrestricted travel to and from the U.S. mainland and Section 936, an IRS loophole that partially exempts companies with factories here from having to pay income tax on Puerto Rico-sourced profits.

Yet for all its close ties to Washington, until recently U.S. cars were prohibitively expensive in Puerto Rico, because of a local excise tax that increased according to a car's weight, engine size and horsepower. As a result, U.S. vehicles -- which were generally larger and more powerful -- were assessed higher taxes, and thus saw their share of the island' auto market shrivel from 72% before the 1973 law was passed to 18% in 1992.

Tired of seeing their revenues shrink, U.S. automakers accused Commonwealth officials of blatantly discriminating against American cars, even though some models were just as fuel-efficient as their lighter Japanese counterparts. In 1991, three Michigan congressmen -- acting at the behest of Ford, Chrysler and General Motors -- demanded repeal of the tax in a circular letter titled "Help Stop Unfair Trade Practices by the Puerto Rican Government."

Interestingly, U.S. cars weren't the only ones who suffered, says longtime Honda distributor Jeronimo Esteve Abril.

"The Ley de Arbitrios [as it was known in Spanish] discriminated against American cars, but also heavier Japanese cars like Honda," said Abril, president of Bella International Inc. in San Juan. "At one time, 160 hp was the limit on horsepower, and the Acura was 161 hp. For that extra one horsepower, we had to pay an additional 5%, which translated into $3,000 or $4,000 in taxes."

The controversial policy was finally revised in October 1992 by former Gov. Rafael Hernández Colón, after the three Michigan lawmakers threatened to take action against Section 936 unless the discriminatory tax was abolished.

Under the new formula, a vehicle's excise tax is determined solely by its manufac-turer's suggested retail price (MSRP) -- without regard to how much a car weighs, how powerful its engine is, or how much it's actually sold for. And for the most part, Puerto Rico's 218 new-car dealers couldn't be happier.

"Our sales have gone through the roof," says Alberic Colón, president of Alberic Colón Auto Sales Inc. and chief of the island's Pontiac Dealers Association. "We were at a disadvantage, because my cars were heavier than the competition, and more powerful. But now our taxes are based on MSRP, and everyone is on the same playing level."

Colón, whose dealership fronts San Juan's Avenida Kennedy -- home to more than a dozen auto dealers -- says he was selling 1,200 GM cars a year before the law was revised. In 1995, he sold 2,312 units.

Thanks to the revised Ley de Arbitrios, total vehicle sales have more than doubled -- from 52,284 units in 1990 to 116,598 units last year. Figuring an average $14,000 per vehicle, that translates into $1.62 billion in 1995 revenues.

"The law has been good for everybody, because it changed a system that distorted prices," said Ramón Vega Díaz, president of Autos Vega Inc. "The government benefitted too, because tax revenues increased from $178 million in fiscal 1992 to a projected $375 million in fiscal 1996. It made the market more competitive. Everybody's selling more."

Adds Mercedes dealer Carlos Quiñones, who is also president of the Puerto Rico Automobile Dealers Association: "People don't have to import deteriorated cars from the mainland anymore. Customers can now buy a new car for what before would have bought them a similar used car."

During the first four months of this year, according to industry statistics, Detroit's "Big Three" accounted for 29.4% of new-car sales: Ford (14.4%), GM (9.9%) and Chrysler (5.1%).

Surprisingly, the jump in U.S. auto sales hasn't come at the expense of Japanese or Korean manufacturers, at least not yet. During the 1973-74 Arab oil embargo, gas prices shot up and Puerto Ricans -- like their counterparts on the U.S. mainland -- switched to more fuel-efficient Japanese models. Many found that the smaller cars withstood the punishment of the island's twisting mountain roads better than American models, were cheaper to maintain and proved more practical for navigating the narrow, traffic-choked streets of Old San Juan, not to mention parking.

As a result, seven out of 10 new vehicles purchased in Puerto Rico are Japanese. As of December 1995, according to industry statistics, the market leader was Mitsubishi -- with 17.6% of total vehicle sales -- followed by Toyota (15.3%), Hyundai (13.2%), Ford (11.6%), GM (9.9%), Nissan (6.7%), Mazda (6.2%), Kia (4.2%) and Chrysler (3.9%). When it comes to truck sales, Ford is clearly the leader, with 21.4% of the market, followed by Mitsubishi with 15.9% and Isuzu with 12.7%).

Ford also leads in the full-size van category, with its E-series capturing 62.1% of the market. Mitsubishi's Expo leads the mini-van market (38.6%), while its Montero rules the crowded sport-utility segment (11.9%). Other category leaders are: large cars (Ford Crown Victoria, 29.7%); full-size (GM Lumina, 24.1%); family cars (Mitsubishi Galant, 29.1%), small cars (Toyota Tercel, 33.1%) and "mini" cars (Hyundai Accent, 84.7%).

In the luxury car market, Mercedes is king, with 30% of the market -- well ahead of Lexus, Cadillac, Infiniti, Lincoln and Audi. Indeed, Mercedes, which sold under 300 cars last year, is faring better than in the past. Under the old system, a Mercedes S-600 would be socked with an 85% excise tax, meaning a customer would have to pay $280,000. These days, the same car costs $160,000.

Nevertheless, industry experts see new-car sales dipping for the first time in several years, to around 105,000 units in 1996 -- perhaps because so many Puerto Ricans now have cars and the market is saturated. Meanwhile, auto dealers are working to bring the excise tax down even further, by having the arbitrio assessed only on the actual selling price of a vehicle, not the MSRP.

"What we originally wanted was a straight tax, like they do in the States," said Quiñones. "We're content with what we got, but there's always room to improve the law."

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