Does Puerto Rico Need a New 936?

Some of the proposals for Puerto Rico’s economic recovery plan include programs reminiscent of Section 936 of the Internal Revenue Code, a special tax break for U.S. corporations that located some part of their production in Puerto Rico.

The idea of the tax break was to provide an incentive for companies to invest in jobs in Puerto Rico. It didn’t turn out that way. Economist Arthur MacEwan puts it clearly in a recent update of his paper, “Quantifying the Impact 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.”

Why does MacEwan take this position when so many observers see the end of 936 as the beginning of Puerto Rico’s financial problems?

Here are some of the data points MacEwan references in his paper:

  • Section 936 was in place for two decades, 1976- 1996, when it began to be phased out. During that time, the U.S. economy grew by 3% per year, but the Puerto Rican economy expanded by just 2.5% annually. Over this 20 year period, the U.S. economy grew 17% more than the Puerto Rican economy, leaving Puerto Rico falling further and further behind.
  • Puerto Rico fell behind not only in comparison to the States, but also in comparison to countries which shared some of its challenges. South Korea, for example, had a GNP 65% lower than Puerto Rico’s in 1970. By 2010, the South Korean per capita GNP was 62% above that of Puerto Rico.
  • 936 firms dominated in four industries; pharmaceuticals, chemicals, electronics, and medical equipment and supplies. Employment in these industries fell by just 1.1% during the period when 936 was being phased out. Manufacturing in Puerto Rico overall saw a 27.5% drop in employment.
  • Pharmaceuticals, by far the most important of the 936 sectors in Puerto Rico, saw a rise of 40% in revenue from exports between 2005 and 2015, while employment in this industry declined by 51%. In other words, the companies that benefited from Section 936 continued to do so after it was phased out. However, those companies chose to cut costs by reducing jobs — a trend in the United States in the same time period, as automation technology advances made machines less costly than human workers.

So 936 didn’t create wealth for Puerto Rico, and its loss didn’t cause the recession that culminated in the current debt crisis. What did cause that recession? MacEwan identifies a number of factors, including the 2008 recession  that affected all of the United States (where manufacturing jobs fell by 19%) and the end of patent protections on some formerly profitable pharmaceuticals.

936 did maximize profits for the firms which took advantage of it, largely at the expense of the U.S. government. MacEwan reports, “According to a U.S. Treasury Department report, in 1987, the middle of the 936 era, it cost the U.S. government on average at least $1.51 in lost tax revenue for each $1.00 in wages paid in Puerto Rico by firms operating under the provisions of Section 936.”

What’s more, the companies that benefited from 936 were generally able to continue to do so by taking on Controlled Foreign Corporation (CFC) status after the end of 936. “CFC status,” says MacEwan, “allowed the U.S.-based firms to continue to avoid U.S. taxes on their Puerto Rican operations as long as they did not return those profits to the parent corporation in the states.”

“The evidence does not support the claim that Section 936 was an important foundation for favorable economic expansion in Puerto Rico when it was in force,” MacEwan concludes, “or that the termination of 936 was an important factor bringing about the severe recession, which began in 2006.”

MacEwan is not alone in his observations. Jennifer González, a current candidate for resident commissioner, recently said of Section 936, “The high cost to the federal treasury and the low correlation to job creation were the determining factors for its elimination, not because I say so, that is what the members of Congress say.”

Read MacEwan’s paper.

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