Section 956: Dead On Arrival

by John Marino

March 15, 2002
Copyright © 2002 THE PUERTO RICO HERALD. All Rights Reserved.

. JOHN MARINOAs the commonwealth reaches its 50th birthday this summer, it is becoming increasingly clear that the political status will have to survive without any special federal industrial lures that have buoyed the Puerto Rico economy for most of the century of United States stewardship of the island.

The Calderón administration suffered yet another setback this week in its hopes to win a new federal tax break for island manufacturers through an amendment to Section 956 of the U.S. Tax Code when Congress released estimates of the program's cost that are more than ten times that of commonwealth estimates.

The proposed amendment would allow controlled foreign corporations in Puerto Rico to repatriate 90 percent of their island profits tax free from Puerto Rico to stateside sister companies.

The Calderón administration has painted the 936 proposal as a "win-win" situation that would help both Puerto Rico and the United States equally.

The island would benefit because it would be given a leg up on competing foreign destinations such as Singapore, Ireland and low wage countries in Asia and Latin America. That's because on top of the local tax exemptions Puerto Rico grants potential investors, it could also throw a federal tax incentive into the mix, something its foreign competitors could not.

Meanwhile, the administration argues that the U.S. Treasury would benefit by offering an "incentive" to Puerto Rico-based companies to repatriate profits back to the United States under favorable tax rates. Without such inducements, island CFCs would continue to ship profits to other foreign operations in order to avoid federal taxation altogether.

The behavior of most companies following the 1996 repeal of Section 936 and Section 30-A, which are being phased out for current beneficiaries through 2005, lends some credence to the Calderón viewpoint. For example, those who remained on the island chose to convert into CFCs in order to avoid federal taxation altogether.

But Congress is clearly not buying the argument.

It estimates the program will cost the U.S. Treasury more than 10 times estimates made by the commonwealth. While the commonwealth put the costs of the program at $1.3 billion over a 10-year period, the bipartisan Joint Committee on Taxation put the price tag at more than $11 billion over an 11-year period.

Worse, a provision granting companies which convert to CFCs special tax provisions on intangibles, which include patents or know-how on manufacturing inventions or the cost of brand name marketing by advertisers, would cost some $21 billion over that period, according to Congress. The commonwealth estimated the cost at $2 billion over 10 years.

Resident Commissioner Aníbal Acevedo Vilá said the Congressional estimates could prompt the commonwealth to drop the intangibles transfer provision. But it's doubtful that such a move would prompt Congress to react more favorably to the proposal.

Ditto for a push to have the Joint Committee on Taxation rethink its 956 cost estimates.

One Senate source close to tax issues, speaking to the San Juan Star, said that when taken in the context of national priorities, the 956 cost was "very high." The source noted that the Senate Energy Committee just agreed on a nationwide energy incentives bill that would cost $16 billion over 10 years.

More than two dozen members of Congress have co-sponsored the 956 legislation, but the main players have yet to commit to the proposal.

Senate Finance Committee Chairman Max Baucus, D-Montana, has called the Calderón administration's arguments persuasive but he remains non-committal.

House Ways and Means Committee Chairman Bill Thomas, R-Calif., meanwhile, has said that he understands the plight of Puerto Rico - burdened with both high wages and the high costs of doing business because of its geographic isolation -- but believes that a regional solution should be made for the economies of the Caribbean rather than individual programs for specific jurisdictions.

The Calderón 956 proposal may sound a whole lot better than Section 936, which was vilified as corporate welfare when eliminated in 1996

And the argument that it is mutually beneficial is not all that far off the mark. When federal tax breaks were first given to corporations operating in Puerto Rico in the 1940s, Congress was as persuaded by the argument that the move would keep U.S. companies from operating overseas and therefore boost the national economy as it was by arguments about the beneficial effect the plan could have on the Puerto Rico economy.

But it is becoming increasingly clear that when Congress eliminated in 1996 Section 936 and Section 30-A, it was walking down a road that it did not intend to turn back on.

The 956 proposal is an innovative idea, but despite its merits, its future is bleak for a very simple reason: special deals for Puerto Rico are simply out of tune with the current realities of globalization and free trade.

Not too long ago, in the run-up to the 1993 status plebiscite, the Popular Democratic Party was proposing incorporating special federal tax benefits such as those afforded by Section 936 into a new improved definition of commonwealth.

The idea, intellectually dishonest at the time, is unthinkable today. When setting about trying to improve commonwealth as it reaches middle age this summer, the PDP needs to stick to the commonwealth's true characteristics.

One of its main economic advantages is that Puerto Rico has its own taxing jurisdiction, making the power of local tax exemption much more potent here than in the 50 states, where investors are still subject to federal taxes. This too, however, can be changed by Congress when it deems fit.

The PDP administration is free to keep lobbying Congress for further federal industrial lures. The pro-statehood New Progressive Party has done the same in trying to keep the Section 30-A wage credit program alive.

But the PDP can no longer argue that such programs are an intrinsic aspect of the commonwealth.

John Marino, City Editor of The San Juan Star, writes the weekly Puerto Rico Report column for the Puerto Rico Herald. He can be reached directly at: Marino@coqui.net

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