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/ Wednesday, February 2, 2022
Puerto Rico’s crippling debt, or how did we get where we are now
The current situation was highly influenced by the phasing out of Section 936, reveals study (First of a series)
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By Zoe Landi Fontana, The Weekly Journal
hroughout 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 labor participation, employment, and the continued services to Forbes 1000 firms. reliance on Federal ‘social support’ programs to The current situation continues to exacerbate raise the continuing dismal per-capital income rates old problems in growth, employment, workforce among the diaspora,” wrote Allio. participation, and long-term development due to By the mid-90s, Section 936’s effectiveness was policies that are passed without regard to their long- questioned by Congress, who found that, among a term effects, Allio argues. lack of other purported economic improvements, “New residents may benefit from income, firms that came to the island incentivized by the interest, capital gains, and property tax exemptions tax benefits of section did not result in much of a while existing residents are excluded and burdened. benefit for the island in terms of level and quality of It’s no surprise that tax jobs that they provided. avoidance is a national Between 1970 and profession,” the report 1990, there was a net reads. loss of over 20,000 jobs In Allio’s report, due to the replacement Puerto Rico’s current of labor-intensive situation was highly industry with capitalinfluenced by the intensive industry, a phaseout of section byproduct of section 936 and constant 936. In this time period unbudgeted 2,243 plants and 29,847 – Arthur MacEwan enhancement of local jobs were created, but Professor Emeritus of Economics social programs (which 1,931 plants closed, resulted in rapidly losing 51,800 jobs. increasing debt), as Allio pointed to the well as the 2008 recession, hurricanes Georges, fact that firms benefiting by Section 936 kept most Irma, and Maria, the Commonwealth’s municipal of their profits, paid no federal taxes, and only bond meltdown, and Governor Luis Fortuño’s around 5% of their revenue went to the Puerto Rican signing of Law 7 in March 2009. government. In 2016, the U.S. Senate Finance Committee Section 936 published a report, authored by Arthur MacEwan, Section 936 of the U.S. Internal Revenue Code Professor Emeritus of Economics at the University was passed in 1976 and exempted US corporations of Massachusetts Boston, stating that “Section 936 from paying taxes on income generated by of the Internal Revenue Code was not an effective manufacturing activities in Puerto Rico. By the means to promote economic growth in Puerto 1980s, an estimated 80% of the U.S.-produced Rico, and the emergence of the current and pharmaceuticals were manufactured in Puerto Rico. long-continuing recession cannot be attributed to “The only problem was that 936 attracted highly the termination of 936. Moreover, at this point, capital intensive versus labor-intensive development U.S. firms are able to operate in Puerto Rico as and did little to change the internal dynamics of Controlled Foreign Corporations (CFCs), which
Section 936 of the Internal Revenue Code was not an effective means to promote economic growth in Puerto Rico.
In fact, Between 1970 and 1990, there was a net loss of over 20,000 jobs due to the replacement of labor-intensive industry with capitalintensive industry. Source: Allio Associates
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).
