Five years ago the mayor of San Juan was running for governor when a relatively unknown economist from California gave him a campaign theme: cut tax rates and this poverty-ridden island would raise its revenues and recover from recession.
Today Carlos Romero Barcelo, in his second term as governor, boasts that his six-year program to cut personal income tax rates by an automatic 5 percent a year has already increased government receipts, and the California economist, Arthur B. Laffer, has caught the ear of the president of the United States.
Puerto Rico is being touted as a model for the supply-side economic theories that President Reagan is urging Congress to adopt -- but interviews with experts here suggest the picture is far murkier than that.
Rep. Jack Kemp (R-N.Y.), a chief congressional spokesman for the Republicans' tax-cut proposals, has called Puerto Rico "the most recent, and one of the most impressive examples of tax-rate reduction without a subsequent decline in revenue" -- a telling point for Democrats who fear that tax cuts will lead to a higher federal deficit.
"We ought to emulate what is going on in Puerto Rico," Kemp told congressional colleagues last year.
A close look at the numbers suggests a far more complex situation than tax-cut advocates admit.
Revenues increased somewhat, but not necessarily more than inflation would have boosted them anyway. And economists here disagree on whether the tax-rate cuts, although politically popular, have helped the economy of this semi-autonomous American colony that suffers from an 18.5 percent unemployment rate and a per-capita income less than half that of the United States as a whole.
"It's ridiculous to talk about the application of a Laffer policy to Puerto Rico," said former governor Rafael Hernandez Colon, adding that Romero raised excise taxes on beer and cigarettes by millions of dollars a year and increased taxes on U.S. corporations.
"When you add up all these new taxes, they come out to a higher amount than the reduction of income taxes which supposedly implement Laffer's theory," Hernandez said.
Hernandez, whom Romero ousted in that 1976 election, says Romero's "demagogic" espousal of tax cuts and his attacks on Hernandez' tax increases "could have been decisive" in the election. By the time Hernandez ran again in 1980, he, too, was campaigning on a tax-cutting platform.
Puerto Ricans, although they pay no federal income taxes, pay higher overall taxes than mainland Americans. When Romero ran in 1976, the highest incomes were taxed here at 87 percent, and a Puerto Rican earning $22,000 a year paid half his income in taxes. Tax evasion was widespread, and Puerto Ricans who had nicknamed the previous governor's 5 percent increase "la vampirita" -- the little vampire -- were ready for change.
In an interview in La Fortaleza, the governor's magnificent palace overlooking the sea, Romero acknowledged that when he hired Laffer, a 40-year-old University of Southern California professor, to do an economic study and later adopted some of his recommendations, he knew he was dealing with a maverick in the economic world.
"Our local guys would say that Laffer was not an economist's economist," said Romero, a hefty, outspoken politician who graduated from Yale University. "My reaction was that we have a lot of tried theories that are not working."
And Laffer, a buoyant personality despite his outsider status, captured the imagination of the governor. "He's a charming person," said Romero, breaking into a broad grin at the mention of Laffer's name. "He's almost impish."
Bertram P. Finn, the governor's chief economic aide, said that Laffer's remedies caused "a great deal of disagreement" among Romero's advisers at first, but Laffer, he added, "is a very good salesman for his product. Most politicians don't understand economic theory. Someone has to interpret it in language they can understand. Laffer's extremely enthusiastic. He's a well-spoken charmer."
Jude Wanniski, then a Wall Street Journal editorialist as well as Laffer's friend and chief publicist, traveled to Puerto Rico in 1976.
"I was hit with a thunderbolt," he said in an interview. "It was like a big light going off in my head. I realized Puerto Rico, with its totally separate fiscal system, would be a perfect economic laboaratory" for supply-side theories.
That doctrine, of which Wanniski and Laffer are the chief advocates in the United States, holds that cutting tax rates -- especially for business and higher-bracket taxpayers who supply investment capital -- will boost the work incentive and thus spur economic growth.
Wanniski first approached then-governor Hernandez, whose advisers, he said, pooh-poohed his message. Then he went to Romero, Hernandez' rival, and "his eyes bugged out. He got all excited," Wanniski said. He introduced Romero to Laffer and arranged a dinner for him at Kemp's home in Bethesda.
Romero, however, mindful of balancing his budget, as Reagan has been, declined to adopt Laffer's whole program of an immediate cut in the top tax rate to 50 percent, the indexing of tax rates to avoid automatic bracket-jumping due to inflation, and the elimination of inheritance taxes.
"I'd be more radical," said Laffer, who is now designing tax cuts for Delaware, Massachusetts and Guam. Nonetheless, he added, "Puerto Rico is clearly a case where supply-side economics has been attempted and been fairly successful."
Romero's gradual 5 percent a year tax-rate cut, which will lead to a 50 percent top bracket next year, did not result in a budget deficit. According to Finn, income tax revenues rose from $440.9 million in 1977 to $514.3 million in 1980, a 16.6 percent increase over three years.
Critics, such as University of Puerto Rico economist Jaime Santiago, attribute the increase to inflation. The governor says that revenues increased somewhat more than inflation, but no studies have been made to prove it, and Puerto Rican inflation estimates are widely considered to be unreliable.
Santiago, pointing out that Puerto Rico has an open economy within the United States, said it is "very strange" to credit economic growth here to the rate reductions when the economy has taken a sharp dip, from a 5.5 percent jump in economic output in 1977 to a 2.8 percent increase in 1980 and a predicted zero-growth rate this year.
Romero counters that the growth, while declining, has been "larger than on the mainland." He attributes that to the tax cuts, but adds "to prove it scientifically, I can't."
Unemployment here reached a peak of 23 percent in April 1977, shortly after Romero took office, declined to 16.6 percent in 1979 and went up to 18.6 percent in January.
Hernandez, who lost to Romero by only two-tenths of a percentage point in the 1980 election, criticizes the Laffer program as "a tax cut that mostly benefits the rich" who get a larger break because of higher incomes. That is the same argument used by mainland Democrats to counter Reagan's proposals.
Hernandez adds, however, that as a politician, "Maybe I would have cut personal income taxes. But I would not have placed any hopes on that tax cut in terms of solving the economic needs of Puerto Rico."