Puerto Rico’s Crippling Debt, or How Did We Get Where We are Now | Business

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Throughout its history, Puerto Rico’s tax policies have prevented the country from developing sustainable economic growth, according to a recently published report by David Allio, principal executive and strategy consultant for Allio Associates, a company that provides services to Forbes 1000 firms.

The current situation continues to exacerbate old problems in growth, employment, workforce participation, and long-term development due to policies that are passed without regard to their long-term effects, Allio argues.

“New residents may benefit from income, interest, capital gains, and property tax exemptions while existing residents are excluded and burdened. It’s no surprise that tax avoidance is a national profession,” the report reads.

In Allio’s report, Puerto Rico’s current situation was highly influenced by the phaseout of section 936 and constant unbudgeted enhancement of local social programs (which resulted in rapidly increasing debt), as well as the 2008 recession, hurricanes Georges, Irma, and Maria, the Commonwealth’s municipal bond meltdown, and Governor Luis Fortuño’s signing of Law 7 in March 2009.

Section 936

Section 936 of the U.S. Internal Revenue Code was passed in 1976 and exempted US corporations from paying taxes on income generated by manufacturing activities in Puerto Rico. By the 1980s, an estimated 80% of the U.S.-produced pharmaceuticals were manufactured in Puerto Rico.

“The only problem was that 936 attracted highly capital intensive versus labor-intensive development and did little to change the internal dynamics of labor participation, employment, and the continued reliance on Federal ‘social support’ programs to raise the continuing dismal per-capital income rates among the diaspora,” wrote Allio.

By the mid-90s, Section 936’s effectiveness was questioned by Congress, who found that, among a lack of other purported economic improvements, firms that came to the island incentivized by the tax benefits of section did not result in much of a benefit for the island in terms of level and quality of jobs that they provided.

Between 1970 and 1990, there was a net loss of over 20,000 jobs due to the replacement of labor-intensive industry with capital-intensive industry, a byproduct of section 936. In this time period 2,243 plants and 29,847 jobs were created, but 1,931 plants closed, losing 51,800 jobs.

Allio pointed to the fact that firms benefiting by Section 936 kept most of their profits, paid no federal taxes, and only around 5% of their revenue went to the Puerto Rican government.

In 2016, the U.S. Senate Finance Committee published a report, authored by Arthur MacEwan, Professor Emeritus of Economics at the University of Massachusetts Boston, stating that “Section 936 of the Internal Revenue Code was not an effective means to promote economic growth in Puerto Rico, and the emergence of the current and long-continuing recession cannot be attributed to the termination of 936. Moreover, at this point, U.S. firms are able to operate in Puerto Rico as Controlled Foreign Corporations (CFCs), which provides them with virtually all the advantages of Section 936 (and does not impose some of the restrictions of 936). Section 936 is a failed policy. It would be the height of folly to reinstitute 936—or of a 936-like program—as a means for establishing economic expansion in Puerto Rico.”

Accumulation and default on debt

In 2016, the year that section 936 completely phased out, Puerto Rico defaulted. As a result, the U.S. Government established the Financial Oversight Management Board, under the guidance of PROMESA, to manage the country’s handling of the debt.

The Commonwealth government is one of the largest employers in Puerto Rico and on average contributes 13.36% of the island’s GDP. In 2020, government positions made up 25% of the workforce, and in the past as high as 30%.

“Having given away the tax base for decades leaves little but empty aspirations. We are, in fact, a welfare society,” said Allio. The labor participation rate is estimated at 38%, according to data by The World Bank. For comparison, the US Bureau of Labor Statistics Dec. 2021 report found that the national civilian labor force participation was at 61.9%.

General sales and excise taxes make up the bulk of revenue generation for the government. Puerto Rico currently has some of the highest tax rates on general sales, alcohol, cigarettes, and cars when compared to other jurisdictions in the U.S.

Yet despite the small base of taxable income generated by the population, a multitude of tax exemptions exist for activities in real estate development, manufacturing, historical preservation, capital investment, exporting, homeownership, and, of course, companies qualifying for tax exemption under Law 60 (Acts 20 and 22).

 



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