Leaders Unite to Include Puerto Rico in Congressional Proposals

With all of the criticism of President Trump’s personal responses to Puerto Rico’s major natural disasters and the territory’s government and his administration’s slow release of the tens of billions of dollars in aid, an obvious question is whether there is a similar issue regarding the Federal response to the COVID-19 health and economic catastrophe.

A proposal by Republican U.S. senators for the third major COVID-19 bill late yesterday demonstrates a bipartisan agreement that Puerto Rico and the other U.S. territories should be treated equally, or at least equivalently, in Federal efforts to combat the challenge.

The legislation introduced yesterday by the Chairman of the Senate Finance Committee, Charles Grassley (R-IA) and other senators would, for example, give residents of the territories who pay tax on local source income only to their territorial governments the same financial assistance given residents of the States: $1,200 for individuals, $2,400 for couples, and $500 per child for individuals who made up to $75,000 in 2018 and couples who made up to $150,000.  The assistance gradually phases out for high earners, with reduced amounts going to those who earned up to $99,000 for an individual and $198,000 for a couple.

A proposal by House of Representatives Financial Services Committee Chairwoman Maxine Waters (D-CA) for monthly payments of $2,000 per person and $1,000 per child would also include the territories equally.

A significant portion of the Senate Republican bill is taken up by language making special provisions for the grants to go to the territorial governments and be distributed by them.

The COVID-19 proposal enacted into law earlier this week also had extensive provisions to treat the territories and their residents equally. These included additional funding to match the increase in the Federal share of the cost of Medicaid because Medicaid in the territories is capped rather than open-ended, as it is in the States.

Similarly, additional funding was provided for Puerto Rico, American Samoa, and Northern Mariana Islands in their capped versions of the unlimited federal Supplemental Nutrition Assistance Program (SNAP, commonly called Food Stamps).

Special provisions were also included to finance paid leave for employees in the territories because they or a family member can’t work because of COVID-19.

Grassley had pledged treating Puerto Rico equally last week in rejecting a Puerto Rican proposal for a special tax benefit for medical supplies production in the territory. Recognizing the U.S. Government desire to reduce reliance on foreign sources of medical goods, particularly from China and India, the proposal noted that the production of many important pharmaceuticals and medical devices is finished in the territory.

This manufacturing has been done historically so that companies can avoid or reduce Federal income taxes.  There are efforts underway to bring special tax treatment back.

  • As proposed by Popular Democratic Party congressional candidate Anibal Acevedo Vila, former Puerto Rico Resident Commissioner (2001-05) and Governor (2005-2009), in a letter to Grassley, the 2017 Federal Tax Reform’s 10.5% tax on income of foreign subsidiaries in Puerto Rico for State-based companies from their State-based work — half the corporate tax rate in the States — would be further reduced to a 5.25% rate.
  • As later proposed by Governor Wanda Vazquez Garced (New Progressive Party) in a letter to congressional leaders, there would be a tax credit for investments in medical products production facilities in territories but not States or the District of Columbia. The letter contradicts itself by also asking for equal treatment for the territory in the response to COVID-19.

 

  • The PROMESA Financial Board wasn’t specific about an incentive but wrote the President and congressional leaders that one should worked out with the Government of Puerto Rico.

 

All of these proposals ignored the initial rejection from Grassley, who has flatly dismissed the idea, referring to company abuses of the former tax exemption for manufacturing income attributed to Puerto Rico, Internal Revenue Code Section 936.

The 936 provision was enacted in 1976 to encourage job-creating investments in Puerto Rico. Instead, it was primarily used by companies that made products which had most of their value due to work in the States developing patents and brand names, particularly pharmaceuticals. A final stage of productions was done in Puerto Rico using relatively few workers so that the profits could avoid Federal tax and also be exempt from most Puerto Rico tax.

Companies saved far more in taxes than they paid in wages or contributed otherwise to Puerto Rico’s economy. At the same time, competitors in the States and States that lost plants to Puerto Rico complained that it was unfair.

The law was amended to prevent the profit-shifting but companies found ways around it. It was reduced from a 100% tax savings to 40% in 1993 but sunset in 1996, effective with the 2006 tax year.

Because Puerto Rico’s recession began that year and manufacturing employment in Puerto Rico has been reduced, many have mistakenly assumed that Puerto Rico’s economic and budgetary problems and manufacturing job losses were due to the repeal.

In fact, the labor-intensive manufacturing that left the territory was in industries such as garment assembly and tuna canning. They were attracted to Puerto Rico initially because it was within the customs territory of the U.S. and their products faced duties and quotas if made abroad. They were also attracted by the islands’ then exemption from the minimum wage in the days before the U.S. adopted extensive environmental laws.

Free trade agreements and increased wage and environmental costs caused them to leave Puerto Rico for foreign countries, not unlike the migration of production in some industries from the States.

The pharmaceutical companies left Puerto Rico in name only. Companies merely replaced their Puerto Rico branches with subsidiaries set up in foreign tax havens (“controlled foreign corporations” or “CFCs”) to continue to avoid Federal tax. In fact, during the decade after 936’s end, CFC income due to work in the States shifted to Puerto Rico increased 30% to $35 billion a year.

The $35 billion is 85% of all off the income of the CFCs in the territory, meaning that only 15% of their income is due to work in Puerto Rico.

One example is Microsoft, which has attributed about $4.5 billion a year in profits to its Puerto Rico subsidiaries. It paid no Federal tax on the income and paid Puerto Rico only about $40 million a year. It’s similar operation in Singapore, where was costs were about the same as in Puerto Rico, paid taxes in Singapore at a rate almost three times as much as in Puerto Rico and its similar operation in Ireland, where manufacturing wage costs are twice as high as in Puerto Rico, paid taxes at a rate almost six times that paid in Puerto Rico.

There have been consistent proposals to replace Sec. 936 by the Government of Puerto Rico and local industry representatives. They have all been rejected by Congress’s tax committees under both Republicans and Democrats and the Department of the Treasury under both Republicans and Democrats.

The current proposals face an uphill battle because members of Congress would not be inclined to provide a greater incentive for medical goods production in Puerto Rico than in any other U.S. area in trying to relocate manufacturing from China to the U.S. Puerto Rico is a major producer of medical goods but the products are also made at many other locations in the States and could be made in additional locations.

 

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