Tax Policy: Puerto Rican Economic Trends (Letter Report, 05/14/97,
GAO/GGD-97-101).
Pursuant to a congressional request, GAO provided information on
economic activity in Puerto Rico, before and after the recent changes in
tax benefits for corporations operating there, focusing on recent trends
in: (1) Puerto Rico's principal economic indicators; (2) investments by
U.S. corporations in Puerto Rico that generate tax-exempt, nonbusiness
income; and (3) investment and employment promoted by Puerto Rico's
Economic Development Administration.
GAO noted that: (1) the recent trends in Puerto Rican economic
indicators show an economy that is growing in income, employment, and
investment in most years; (2) although the growth in these indicators
continued after the 1993 changes to the section 936 tax credit, GAO
cannot conclude that the changes have had no effect on the Puerto Rican
economy; (3) income as measured by Puerto Rico's gross domestic product
and gross national product both increased between 1982 and 1996, with
the increases continuing at about the same rates after the 1993 changes
in the credit; (4) although the share of domestic net income of Puerto
Rican residents declined from 69.3 to 59.8 percent between 1982 and
1996, their net income grew in absolute terms from $16.3 billion to
$23.8 billion; (5) unemployment declined in most years between 1982 and
1996 and also declined or remained unchanged in every year after the
1993 changes to the credit; (6) investment spending for the plant and
equipment that increases the economy's ability to generate income also
increased in most years during this period; (7) although investment
increased, and unemployment did not increase, after the changes to the
credit, GAO does not know if the rate of change of either of these
indicators would have been greater if the credit had not been changed;
(8) during the last 2 calendar quarters of 1996, when the tax benefits
for QPSII were ending, the total value of investments in Puerto Rico
that formerly would have generated QPSII benefits grew from about $15.6
billion to $16.4 billion and then fell to about $14.6 billion; (9) a
recent amendment to a Puerto Rican financial regulation may have
influenced the financial investment behavior of possessions corporations
during that period even more than the repeal of the exemption for QPSII;
(10) it is possible that the funds that possessions corporations
reinvest in Puerto Rico's financial system simply displace other funds
that would have been available to Puerto Rican businesses, rather than
expand the pool of available funds; (11) the amount of foreign
investment dollars committed to projects promoted by the Economic
Development Administration (EDA) were at their highest levels in the
late 1980s and early 1990s and have generally declined thereafter; and
(12) this trend continued immediately after the 1993 changes in the
section 936 tax credit, when in 1994 investment by overseas businesses *
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-97-101
TITLE: Tax Policy: Puerto Rican Economic Trends
DATE: 05/14/97
SUBJECT: Territories and possessions
Economic development
Investments abroad
Economic analysis
Economic indicators
Tax law
Tax credit
Unemployment rates
Corporations
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Cover
================================================================ COVER
Report to the Chairman, Committee on Finance, U.S. Senate
May 1997
TAX POLICY - PUERTO RICAN ECONOMIC
TRENDS
GAO/GGD-97-101
Puerto Rican Economic Trends
(268789)
Abbreviations
=============================================================== ABBREV
EDA - Economic Development Administration
GDP - gross domestic product
GNP - gross national product
IRC - Internal Revenue Code
PRIDCO - Puerto Rico Industrial Development Corporation
QPSII - qualified possessions source investment income
Letter
=============================================================== LETTER
B-276674
May 14, 1997
The Honorable William V. Roth, Jr.
Chairman, Committee on Finance
United States Senate
Dear Mr. Chairman:
In response to your request, this report provides information on
economic activity in Puerto Rico, before and after the recent changes
in U.S. tax benefits\1 for corporations operating there.
Corporations that receive these tax benefits represent a significant
sector of the Puerto Rican economy. In recent years Congress has
reduced the size of the tax benefits and set an expiration date for
the remaining benefits. The last benefits are authorized to be
available for tax years beginning before January 1, 2006, although
the administration's fiscal year 1998 budget proposes to extend the
availability of some of the tax benefits indefinitely.
In light of these tax law changes, you asked us to present
information on the recent trends in
Puerto Rico's principal economic indicators;
investments by U.S. corporations in Puerto Rico that generate
tax-exempt, nonbusiness income; and
investment and employment promoted by Puerto Rico's Economic
Development Administration.
--------------------
\1 Under section 936 of the Internal Revenue Code (IRC).
BACKGROUND
------------------------------------------------------------ Letter :1
THE SECTION 936 TAX CREDIT
---------------------------------------------------------- Letter :1.1
Income derived from operations of U.S. corporations in U.S.
possessions has been subject to special tax provisions since the
Revenue Act of 1921. These provisions were primarily intended to
help U.S. corporations compete with foreign firms in the Philippines
(then a U.S. possession). With the Tax Reform Act of 1976, Congress
connected the special tax provisions with the development of
possessions' economies. The 1976 Act created section 936 of the IRC,
which revised the treatment of corporate income from U.S.
possessions. The stated purpose of the tax credit established under
that section was to "assist the U.S. possessions in obtaining
employment producing investments by U.S. corporations."
Prior to 1994, the section 936 tax credit was equal to the full
amount of the U.S. income tax liability on income from a possession.
The credit effectively exempted two kinds of income from U.S.
taxation:
income from the active conduct of a trade or business in a
possession, or from the sale or exchange of substantially all of
the assets used by the corporation in the active conduct of such
trade or business and
certain income earned from financial investments in U.S.
possessions or certain foreign countries, generally referred to
as qualified possession source investment income (QPSII).
In order for the income from an investment to qualify as QPSII, the
funds for the investment must have been generated from an active
business in a possession, and they must be reinvested in the same
possession. Dividends repatriated from a U.S. subsidiary to a
mainland parent have qualified for a dividend-received deduction
since 1976, thus allowing tax-free repatriation of possessions
income.
The 1993 Budget Act\2 placed caps on the amounts of section 936
credit that corporations could earn for tax years beginning in 1994
or later. The Small Business Job Protection Act of 1996 repealed the
tax credit for taxable years beginning after 1995.\3 However, the act
provides transition rules under which a corporation that was an
existing credit claimant is eligible to claim credits with respect to
possession business income for a period lasting through taxable years
beginning before 2006. For tax years beginning after December 31,
1995, QPSII received or accrued after June 30, 1996 may not be used
in figuring the credit.
--------------------
\2 Omnibus Budget Reconciliation Act of 1993, P. L. No. 103-66, S
13227, 107 Stat. 312, 489 (1993). Appendix I provides additional
details on the changes made to the credit by this and other acts
signed into law since 1982.
\3 Small Business Job Protection Act, P.L. No. 104-188, S 1601, 110
Stat. 1755, 1827 (1996).
PUERTO RICAN INVESTMENT
INCENTIVES
---------------------------------------------------------- Letter :1.2
Over the years, the government of Puerto Rico has taken several steps
to encourage corporations to invest in the island and to retain their
earnings there. Under Puerto Rico's current industrial incentives
law, corporations engaged in manufacturing or export services
generally are allowed 90-percent exemptions on their industrial
development income.\4 These exemptions are valid for 10 to 25 years,
depending on the location of the business' operations. The Puerto
Rican government encourages the partially exempt corporations to
reinvest their business profits in the island by including in the
definition of industrial development income all income derived from
specified financial assets. This financial income exempted under
Puerto Rican law was also treated as QPSII under federal tax law if
it was earned by a possessions corporation.\5
The "tollgate tax," which Puerto Rico imposes on dividends that
resident corporations pay to nonresident shareholders, provides an
additional incentive for eligible corporations to reinvest their
earnings in Puerto Rico. The rate of this tax on dividends paid out
of the income of a tax exempt business is generally 10 percent.
However, the rate is reduced if a corporation reinvests a certain
portion of its earnings in Puerto Rico for a period of 5 or more
years.
The Economic Development Administration (EDA)/Industrial Development
Company (PRIDCO) of Puerto Rico promotes investments on the island by
both local and overseas businesses. Generally, but not always, the
investments promoted by EDA receive tax exemptions under Puerto Rican
tax incentive legislation. EDA compiles data on the number of
"promotion projects" initiated each month as a result of its
activities. It also compiles data on the amount of investment and
employment that businesses commit to when initiating a project.
--------------------
\4 The current Tax Incentives Act became effective in 1987 and is due
to expire at the end of 1997. The government is currently drafting
new incentive legislation.
\5 A "possession corporation" is one that elects to be taxed under
section 936 of the IRC and meets the following two requirements:
over a 3-year period preceding a taxable year, 80 percent or more of
its income must be derived from sources within a possession; and 75
percent or more of its income must be derived from the active conduct
of trade or business within a possession. To qualify for both U.S.
and Puerto Rican tax benefits, the corporation would have had to make
the investment in the specified assets with earnings derived from its
active business in Puerto Rico.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
The recent trends in Puerto Rican economic indicators show an economy
that is growing in income, employment, and investment in most years.
Income and employment are traditional indicators of current economic
performance, while investment is an indicator of the economy's
capacity to increase income and employment in the future. Although
the growth in these indicators continued after the 1993 changes to
the section 936 tax credit, we cannot conclude that the changes have
had no effect on the Puerto Rican economy. The Puerto Rican economy
is strongly influenced by the U.S. economy. If the changes in the
credit have had any negative impact on Puerto Rico's economy to date,
this may have been offset by the positive influence of the U.S.
economic recovery after 1991. Recent economic initiatives by the
Government of Puerto Rico also may have offset any such impacts.
Furthermore, the effect of the credit changes may require several
years to have an impact on the Puerto Rican economy because (1) it
may take time for companies to adjust their investment plans and (2)
each year's investment by companies represents a relatively small
proportion of the commonwealth's total capital stock, which generates
employment and income.
Income as measured by Puerto Rico's gross domestic product (GDP) and
gross national product (GNP) both increased between 1982 and 1996,
with the increases continuing at about the same rates after the 1993
changes in the credit. GDP, a measure of the total income produced
in Puerto Rico, grew at a faster rate than GNP, which measures the
portion of total income received by Puerto Rican residents. The
faster rate of growth of GDP compared with GNP means that an
increasing portion of the income produced in Puerto Rico went to U.S.
and foreign investors. These trends are consistent with a
development strategy based on attracting external investment.
Although the share of domestic net income of Puerto Rican residents
declined from 69.3 to 59.8 percent between 1982 and 1996, their net
income grew in absolute terms from $16.3 billion to $23.8 billion.\6
Unemployment declined in most years between 1982 and 1996 and also
declined or remained unchanged in every year after the 1993 changes
to the credit. Investment spending for the plant and equipment that
increases the economy's ability to generate income also increased in
most years during this period. After leveling off for several years
after 1989, possibly due to the U.S. recession, investment increased
again in 1995 and 1996. The section 936 tax credit was intended to
promote investment and employment in Puerto Rico. Although
investment increased, and unemployment did not increase, after the
changes to the credit, we do not know if the rate of change of either
of these indicators would have been greater if the credit had not
been changed.
During the last 2 calendar quarters of 1996, when the tax benefits
for QPSII were ending, the total value of investments in Puerto Rico
that formerly would have generated QPSII benefits grew from about
$15.6 billion to $16.4 billion and then fell to about $14.6 billion.
A recent amendment to a Puerto Rican financial regulation may have
influenced the financial investment behavior of possessions
corporations during that period even more than the repeal of the
exemption for QPSII. Consequently, that investment behavior may be a
poor indicator of the corporations' longer-term reaction to the
repeal.
It is possible that the funds that possessions corporations reinvest
in Puerto Rico's financial system simply displace other funds that
would have been available to Puerto Rican businesses, rather than
expand the pool of available funds. A simple comparison of trends
shows that total investment in buildings, machinery, and equipment
has grown in all but 1 year since 1987, despite the fact that the
amount of exempt investment funds held in Puerto Rican financial
institutions declined in all but 2 years during that period.
The amount of foreign investment dollars committed to projects
promoted by EDA were at their highest levels in the late 1980s and
early 1990s and have generally declined thereafter. This trend
continued immediately after the 1993 changes in the section 936 tax
credit, when in 1994 investment by overseas businesses in EDA
promotions was at its lowest level for any year between 1982 and
1996. However, this investment increased moderately in 1995 and
1996.
--------------------
\6 Unless otherwise noted, all of the dollar values presented in this
report have been restated in constant 1996 dollars. Similarly, all
growth rates have been computed as changes in constant-dollar
figures.
OBJECTIVES, SCOPE, AND
METHODOLOGY
------------------------------------------------------------ Letter :3
To present the trends in Puerto Rican economic indicators, we
obtained the latest economic data available from the Puerto Rican
Planning Board. To present the trends in qualified possessions
source investments, we obtained the latest data available from Puerto
Rico's Commissioner of Financial Institutions concerning exempt
business investments in financial assets in Puerto Rico. To present
the trends in investment and employment promoted by Puerto Rico's
EDA, we obtained the most recent data compiled on those items by EDA.
We also interviewed officials from the aforementioned agencies as
well as from the Government Development Bank of Puerto Rico and the
Puerto Rican Department of the Treasury on issues relating to data
and to Puerto Rican tax laws and industrial incentives laws.
We restated all dollar figures in constant 1996 dollars, using the
most appropriate price indexes available. In most cases we used the
implicit price deflator for Puerto Rico's GNP.\7 We did not
independently verify the accuracy of the data we obtained for this
report.
We also reviewed publications of the U.S. Treasury Department and
the Internal Revenue Service and some of our prior reports relating
to activities of possessions corporations and the effectiveness of
the section 936 tax credit. We did not attempt to estimate the
effects of the recent changes in the section 936 tax credit on the
Puerto Rican economy. We have simply described changes in that
economy in recent years.
We did our work in Washington, D.C., in March and April 1997 in
accordance with generally accepted government auditing standards. We
requested comments on a draft of this report from the Secretary of
the Treasury of the Commonwealth of Puerto Rico, Puerto Rico's
Commissioner of Financial Institutions, the heads of Puerto Rico's
Planning Board, and Economic Development Administration, and from the
Secretary of the Treasury. These comments are summarized and
discussed at the end of this report and are reprinted in appendices
IV through VII.
--------------------
\7 The implicit price deflator for Puerto Rico's GNP is available
only for the end of each fiscal year. Puerto Rico's fiscal year ends
June 30th. In order to avoid distorting end-of-year adjustments in
the report graphs that display quarterly data, we estimated quarterly
deflators by assuming that the annual growth in the deflator would
occur at a constant rate throughout the year. Also, in order to
present consistent trend lines in the cases where our quarterly data
extends to December 1996, we projected the deflator to grow for the
last two calendar quarters of 1996 at the same pace it did between
fiscal year 1995 and fiscal year 1996. Figures for 1996 that we cite
in the text have not been adjusted and, therefore, are slightly
higher than the adjusted figures represented in the graphs.
PUERTO RICO'S ECONOMY
------------------------------------------------------------ Letter :4
As shown by its GNP and GDP, Puerto Rico's economy has been growing
in most years, and this trend continued in the 3 years immediately
following the 1993 changes to the section 936 tax credit. (See fig.
1.) Between 1982 and 1996, Puerto Rico's per capita GNP grew at an
annual rate of 1.7 percent, and its GDP grew at an annual rate of 3.5
percent. The growth of both indicators slowed somewhat after 1990
following the recession that occurred in the U.S., but per capita GDP
began to grow more quickly in 1992 as did per capita GNP in 1993.
Figure 1: Gross Domestic and
Gross National Product Per
Capita, 1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GDP
and GNP deflators.
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years.
The faster rate of growth for Puerto Rico's GDP compared with GNP
means that an increasing portion of total income produced in Puerto
Rico went to U.S. and foreign investors rather than to Puerto Rican
residents. GDP is a measure of total income produced in Puerto Rico,
and GNP is a measure of the income produced that is received by the
residents of Puerto Rico. The difference between the two represents,
for the most part, remittance of profit and interest income to U.S.
and foreign investors. The trends in GDP and GNP are consistent with
Puerto Rico's development strategy, which emphasizes long-term tax
reductions to firms that locate in Puerto Rico, and with the
provisions of the U.S. IRC--such as the section 936 tax credit,
which allowed tax-free repatriation of profits to the mainland.
Although the share of residents of Puerto Rico in total net income
from property and employee compensation declined from 69.3 to 59.8
percent between 1982 and 1996, residents' income grew in absolute
terms from $16.3 billion to $23.8 billion. (For more details on
resident and nonresident income in Puerto Rico, see app. II.)
Investment in Puerto Rico, which is a key factor in the growth in the
Puerto Rican economy, has begun to grow again after leveling off in
the early 1990s. (See fig. 2.) Gross domestic fixed investment is
the amount of resources used to replace capital consumed during the
year and to add to the capital stock. This investment includes both
public and private spending on the construction of housing and
production facilities, and spending on machinery and equipment.
Gross private fixed investment grew significantly between 1982 and
1989 and then leveled off for several years, possibly due to the
recession that occurred in the United States. Growth in investment
picked up again in 1995 and 1996. (See app. II for more details on
investment.)
Figure 2: Public and Private
Gross Fixed Investment,
1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflators for investment.
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years.
The section 936 tax credit was intended to promote investment and
income growth in Puerto Rico, and the limitations on the credit may
reduce the attractiveness of U.S. investment in Puerto Rico.
Although investment and income have grown after the limitations
became effective, we cannot conclude that the credit changes have not
had any effect on investment or income. The rates of growth may have
been greater without the credit changes. Moreover, it may require
more years for the credit changes to affect investment and income
because (1) it may take time for companies to adjust their investment
plans and (2) each year's investment by companies represents a
relatively small proportion of the commonwealth's total capital
stock, which generates employment and income.
From 1982 to 1996, unemployment in Puerto Rico generally declined,
while the participation of Puerto Rican residents in the labor force
increased. (See fig. 3.) The unemployment rate in Puerto Rico was
23.5 percent in 1983, following the recession that the United States
entered in 1981 and 1982, but declined in most years after 1983 to
reach a low of 13.8 percent in 1995 and 1996. The labor force
participation rate increased during this period from an average rate
of 43 percent during the 1980s to an average of 46 percent during the
1990s. The trend in employment continued after the changes to the
section 936 tax credit with the unemployment rate falling or
remaining unchanged in every year after 1993.
Figure 3: Labor Participation
and Unemployment Rates,
1982-1996
(See figure in printed
edition.)
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years.
Total nonagricultural employment in establishments in Puerto Rico
grew from 660,000 in 1982 to 945,000 in 1996. Over this period, the
share of manufacturing employment declined from 22.4 percent of the
total to 16.3 percent, and the share of government employment fell
from 36.2 percent to 32.6 percent. Manufacturing employment has
actually fallen in absolute terms since it peaked in 1990. In
contrast, the share of employment in the retail trade sector rose
from 12 percent to 15.8 percent, and the share of the nonfinancial
service sector rose from 13.3 percent to 18.5 percent. (For more
details on employment in Puerto Rico, see app. II.)
RECENT TRENDS IN QUALIFIED
POSSESSIONS SOURCE INVESTMENTS
------------------------------------------------------------ Letter :5
Prior to 1996, possessions corporations with active trades or
businesses in Puerto Rico could reinvest the earnings from those
activities in eligible financial investments in Puerto Rico and earn
income that was effectively exempt from both U.S. and Puerto Rican
income taxes.\8 For tax years beginning after December 31, 1995,
QPSII received or accrued after June 30, 1996, does not qualify for a
federal tax credit.\9 However, the Puerto Rican income tax exemption
and tollgate tax both remain in place and provide some disincentive
to an immediate repatriation of all financial assets held by
possessions corporations.
As of December 1996, total investment in the exempt financial assets
amounted to $14.6 billion, or $3,927 per resident of Puerto Rico.
This $14.6 billion figure is the best available accounting of the
current value of investments that formerly would have generated tax
benefits under the QPSII credit. Almost all investments that would
have generated QPSII tax benefits are included in that amount,\10 and
only about 1 percent of that amount is attributable to businesses
that would not have qualified for QPSII benefits.\11 Exempt
businesses can make eligible financial investments either directly or
through the intermediation of eligible financial institutions.
Businesses invested $10.5 billion of the $14.6 billion through
financial institutions and invested the remaining $4.1 billion
directly.
Figure 4 presents aggregate data available on exempt financial
investments in recent years.\12 Total exempt financial investment
grew noticeably during the second and third calendar quarters of
1996, reaching $16.4 billion at the end of September 1996. Most of
this increase was offset by a decline during the fourth quarter of
1996. During those 3 quarters, exempt investments in eligible
financial institutions grew more rapidly and then declined less
sharply than direct exempt financial investments. Moreover, as the
data in figure 5 indicate, there was a pronounced shifting of funds
out of instruments with maturities of 1 year or less and into
instruments with longer maturities.
Figure 4: Exempt Financial
Investments, 1992-1996
(See figure in printed
edition.)
Note: Data points represent end of quarter balances. Figures were
adjusted for inflation using the Puerto Rican GNP deflator. Data on
direct and total investment were available only since June 1995.
Source: Government of Puerto Rico, Commissioner of Financial
Institutions.
Figure 5: Exempt Investments
in Eligible Financial
Institutions, by Maturity,
1992-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflator.
Source: Government of Puerto Rico, Commissioner of Financial
Institutions.
According to Puerto Rico's Commissioner of Financial Institutions,
much of the short-term growth in investments with longer maturities
may be a response to a recent amendment to the commonwealth's
regulation that governs tax exempt funds held in eligible financial
institutions. The amendment had the affect of reducing the rate of
interest that financial institutions could pay on exempt funds placed
in instruments with maturities of 5 years or more. Possessions
corporations that planned on reinvesting earnings in Puerto Rico to
obtain a lower tollgate tax rate are likely to have accelerated their
investments in long-term instruments in order to lock in more
favorable rates before the effective date of the amendment.\13
Due to the influence of the amendment to Puerto Rico's financial
regulation, the investment behavior of possessions corporations
during the first 6 months after the repeal of QPSII may be a poor
indicator of their longer-term reaction to the repeal. Nevertheless,
the sharp increase in long-term investments held in eligible
financial institutions indicates that those funds, at least, are not
likely to be repatriated in the immediate future.
--------------------
\8 A possessions corporation must also have been granted an exemption
under Puerto Rico's industrial incentives law to receive this double
benefit. Historically, almost all possessions corporations have been
granted at least partial exemptions from Puerto Rican income tax.
According to IRS, for tax year 1993 there were about 455 active
possessions corporations in Puerto Rico. Data from the Puerto Rican
Department of Treasury show that 439 possessions corporations
received at least partial exemptions in fiscal year 1993.
\9 According to Puerto Rico's Commissioner of Financial Institutions,
most of the tax-year ends for possessions corporations with large
investments in Puerto Rican financial institutions are October 31 and
November 30. For those corporations, the QPSII benefits ended as of
October 31 and November 30, 1996.
\10 Possessions corporations operating in Puerto Rico did not receive
much, if any, tax benefit from section 936 unless their income from
Puerto Rico was also exempt from the commonwealth's income tax. In
the absence of section 936, the corporations would have received
foreign tax credits for income taxes paid to Puerto Rico. These
foreign tax credits would have provided roughly the same benefit as
the section 936 credit. Consequently, only financial investments
that produced Puerto Rican exempt income would generate tax benefits
under the QPSII credit. The $14.6 billion figure is the Government
of Puerto Rico's best accounting of all financial investments in
Puerto Rico that produce tax exempt income.
\11 Locally owned Puerto Rican businesses that have been granted
industrial incentive exemptions may also reinvest their earnings in
the eligible financial assets. However, an official from Puerto
Rico's Department of Treasury told us that possessions corporations
earned 99 percent of all income from eligible financial assets.
\12 Although the government of Puerto Rico has compiled data on the
amount of eligible investments in financial institutions for many
years, it has been able to collect data on the amount of eligible
investments that corporations make directly only since June of 1995.
\13 The effective date of the amendment was October 1, 1996; however,
some funds that were held in the Government Development Bank were
allowed to be converted to longer maturities after that date, under
the old rules.
NO CLEAR RELATIONSHIP
BETWEEN TREND IN EXEMPT
INVESTMENTS IN FINANCIAL
INSTITUTIONS AND TREND IN
TOTAL INVESTMENT
---------------------------------------------------------- Letter :5.1
It is possible that the funds that possessions corporations reinvest
in Puerto Rico's financial system simply displace other funds that
would have been available to Puerto Rican businesses, rather than
expand the pool of available funds. A 1989 report by the U.S.
Treasury Department on the effects of the possessions tax credit
concluded that the exemption for QPSII likely had little effect on
total real investment in Puerto Rico. The report noted that
"In spite of the fact that no 936 funds were available, a much
higher level of real private investment was financed in the
early 1970s than in the first ten years after the enactment of
the QPSII provision. The fact that most of the fluctuations of
total private investment since 1976 have been attributable to
cyclical changes in inventories also suggests that the
availability of 936 funds has not had a major impact on Puerto
Rican growth."\14
The simple graphical comparison in figure 6 reveals no obvious
relationship between (1) changes in exempt investment funds held in
eligible financial institutions and (2) total gross fixed investment
in Puerto Rico each year. Figure 6 shows that the balances of exempt
investments in financial institutions declined in every year after
1987, except 1992 and 1995.\15 This pattern of divestment of
financial assets had no obvious impact on the steady additions to
gross fixed investment in Puerto Rico in most years since 1987. We
do not know what the year-to-year changes have been in the financial
assets that possessions corporations hold directly.
Figure 6: Gross Fixed
Investment and Changes in
Exempt Investment Funds in
Eligible Financial
Institutions, 1983-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GDP
and GNP deflators. The data on exempt investment funds for each year
represent the difference between the average daily balances for
December of that year and the average daily balance for the preceding
December. Exempt investment fund data for December 1991 were not
available; data for January 1992 were used as substitutes.
Source: Government of Puerto Rico, Commissioner of Financial
Institutions.
--------------------
\14 U.S. Department of the Treasury, The Operation and Effect of the
Possessions Corporation System of Taxation, Sixth Report, Mar. 1989,
p. 80.
\15 Part of the decline in balances since 1987 may be attributable to
changes made to the possessions tax credit by the Tax Reform Act of
1986. That act increased the share of a possessions corporation's
gross income that has to be derived from the active conduct of a
trade or business from 65 percent to 75 percent. QPSII is passive
income, and some corporations may have had to reduce the amount of
that type of income they earned to meet the new requirement.
Financial regulations introduced by the government of Puerto Rico in
1988 may have been another factor contributing to the decline in
exempt investments in financial institutions. The new regulations
discouraged institutions from attracting funds from possessions
corporations with the intention of investing the money outside of
Puerto Rico.
THE ECONOMIC DEVELOPMENT
ADMINISTRATION OF PUERTO RICO
------------------------------------------------------------ Letter :6
The EDA promotes investments in Puerto Rico by local and overseas
businesses. The EDA promotions generally receive tax exemptions and
include commitments to hire and pay employees and to invest capital
in amounts negotiated between EDA and the investors. The promotions
that EDA calls "nonlocal," (i.e., at least 50 percent of the capital
invested comes from the United States or other foreign countries)
usually involve U.S.-owned possessions corporations. According to an
EDA official, data regarding the investment dollars, employment, and
payroll committed to these projects are likely to be an early
indicator of the impact of the credit changes on U.S. investment in
Puerto Rico. Compared with the investment data presented in figure
2, the data on investment commitments provide a view of an earlier
stage of the investment pipeline. For example, investment dollars
committed in 1996 may not appear in the government's final accounting
of investment expenditures until 1997 or later.
The number of nonlocal promotions was greatest in 1988 when 120
businesses were promoted by EDA. Nonlocal promotions declined in
most years after 1988, with this trend of generally declining
promotions continuing after the 1993 changes in the tax credit.
Nonlocal promotions numbered 33 in 1994, the smallest number of
nonlocal promotions for any year between 1982 and 1996.
Investment committed to EDA promotions by nonlocal businesses was
greatest in the late 1980s and early 1990s but generally declined
thereafter. Investment committed to nonlocal promotions, which
tended to be more capital intensive than local promotions, reaching
its highest level of $363.5 million in 1990. This investment
continued a generally declining trend in 1994, immediately after
changes in the credit, but increased moderately in 1995 and 1996.
(For more details about EDA promotions, see app. III.)
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :7
We obtained written comments on a draft of this report from the
Secretary of the Treasury of the Commonwealth of Puerto Rico, Puerto
Rico's Commissioner of Financial Institutions, the Acting Chairman of
the Puerto Rico Planning Board, and the Acting Administrator and
Chief Executive Officer of Puerto Rico's Economic Development
Administration. We received oral comments on our draft from an
economist from the U.S. Department of the Treasury's Office of Tax
Analysis. Treasury's Deputy International Tax Counsel also reviewed
the draft but had no comments.
The Secretary of the Treasury of Puerto Rico agreed that the
conclusions in our draft were generally consistent with the data we
reviewed. However, he said that the draft did not consider economic
reforms implemented by the Government of Puerto Rico since 1993,
including new incentives and initiatives to promote tourism,
agriculture, research and exports; reductions in individual and
corporate income tax rates; investments in infrastructure; and
modification of financial regulations to reduce negative effects
arising from the elimination of the credit for QPSII. The Secretary
said that the government's "New Economic Model," along with the
expansion of the U.S. economy, had counteracted some of the effects
of recent reductions in section 936 tax benefits. Despite these
reforms, however, the Secretary was concerned with the future of
Puerto Rico's manufacturing sector and the need to further reduce the
commonwealth's high unemployment rate and raise its per capita
personal income. The Secretary stated that, for these reasons,
Puerto Rico needs a revision of section 30A of the IRC that would
provide federal tax benefits to new investments in Puerto Rico;
specifically a stable wage tax credit as an incentive to U.S.
manufacturing firms operating there.
We agree it is possible that recent economic initiatives of the
Government of Puerto Rico may have partially counteracted potential
negative effects of the changes in section 936. We have added
language to this effect in our final report. It was beyond the scope
of our work to evaluate proposed revisions of section 30A.
The Commissioner of Financial Institutions concurred in general terms
with the conclusions of our draft regarding exempt investment funds
in Puerto Rico. He specifically acknowledged that the level of
exempt funds in eligible financial institutions does not affect the
level of investment in Puerto Rico. The Commissioner provided
additional information regarding several factors, including a change
in a commonwealth financial regulation, that explained the trends in
exempt investment funds during 1996 that we had described in our
draft. He noted that corporations with tax years ending after the
middle, but before the end, of the calendar year could take advantage
of the QPSII tax benefit for a few months after June 30, 1996. The
Commissioner also noted that the Government of Puerto Rico was
implementing a capital markets reform, which, along with it's 1994
tax reform and a significant modernization of the commonwealth's
legal and regulatory framework, has prepared Puerto Rico's financial
system to be competitive, even without the QPSII benefits. He,
nevertheless, supported enhanced benefits under section 30A to help
mitigate any possible long-term adverse effects of the repeal of
QPSII. We have revised our discussion of trends in exempt investment
funds to reflect the additional information provided by the
Commissioner.
The Puerto Rico Planning Board reviewed our use of their data and
provided some additional and updated data. The Planning Board also
noted several apparent discrepancies between the data that we report
and the data that they provided to us. We made some changes to
reflect the new data provided by the Planning Board. In most cases
we made no changes where the board identified apparent discrepancies,
because the discrepancies were small and due to differences in
rounding methods.
The Planning Board also commented that the year 1982, which was used
as the base year in most growth rate calculations, was a recessionary
year and that this could affect the calculation of the growth rates
for GNP and GDP per capita. We agree that the choice of base year
can affect growth-rate calculations. For example, the growth in GNP
per capita would have been slightly lower with 1981 as the base year
and slightly higher with 1983 as the base year. However, our purpose
was to report trends in the data. The growth rates were used chiefly
to summarize the direction of these trends, which was unaffected by
the choice of base year.
The Planning Board also commented that caution should be used in
reporting GDP per capita because it could be misinterpreted as a
measure of the resident population's well-being, even though it
includes income received by nonresidents of Puerto Rico. We agree
and we believe that our report clearly describes GDP per capita and
distinguishes it from GNP per capita, which is a measure of the
income received by residents of Puerto Rico.
The Planning Board provided new information on the number of
possessions corporations that received at least partial exemptions in
fiscal year 1993. They also said that IRS reported that about 474
active possessions corporations operated in Puerto Rico for tax year
1993. After checking with IRS, we determined that there were 474
active possessions corporations in total. Only 455 of those
corporations actually operated in Puerto Rico. We use the updated
information in this report.
The Economic Development Administration provided comments to clarify
our description of their promotions. We have incorporated their
comments in our report where appropriate.
The economist from the U.S. Treasury Department suggested minor word
changes to appendix I, which we made, where appropriate. He also
suggested that it would be of interest to have some discussion of the
spread between Eurodollar interest rates and the rates that Puerto
Rican financial institutions were offering on tax exempt funds. He
said that Treasury had found that the spreads were not significant in
the late 1980s. This would imply that the QPSII benefits may not
have had a great impact on the cost of capital in Puerto Rico. We
agree that evidence of a small difference between Eurodollar rates
and those paid on exempt funds in Puerto Rico would imply that the
QPSII provision may not have significantly reduced the cost of
capital (which, in turn, could have expanded total investment) in
Puerto Rico. An analysis that would allow us to determine whether or
not the current spreads between these rates are significant was
beyond the scope of this report.
---------------------------------------------------------- Letter :7.1
Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from the date of this
letter. At that time we will send copies of this report to the
Ranking Minority Member of the Senate Committee on Finance and to the
chairmen and ranking minority members of other appropriate
congressional committees. We will also send copies to the Secretary
of the Treasury, representatives of the Government of Puerto Rico,
and other interested parties. Copies will also be made available to
others upon request.
This work was performed under the direction of James Wozny, Assistant
Director, Tax Policy and Administration Issues. Major contributors
to this report are listed in appendix VI. If you have any questions
please contact me on (202) 512-9110.
Sincerely yours,
James R. White
Associate Director, Tax Policy
and Administration Issues
DETAILS ON CHANGES IN THE SECTION
936 TAX CREDIT SINCE 1982
=========================================================== Appendix I
In the 1982 Tax Equity and Fiscal Responsibility Act and the 1986 Tax
Reform Act, Congress adjusted the section 936 provisions in an
attempt to reduce the ratio of federal revenue loss to employment
created and investments made in U.S. possessions. Congress
principally adjusted the tax treatment of income derived from
intangible assets (such as trademarks, patents, and trade names) and
passive investments.
Before the 1982 and 1986 adjustments, corporations could (1) reduce
their U.S. income taxes by deducting from their U.S. revenues
research and development expenses that led to a patent and then (2)
transfer the patent (or other intangible asset) to Puerto Rico and
realize tax-free income under section 936 from its use in Puerto
Rico. In the 1982 act, Congress required that companies allocate
some of their income realized in Puerto Rico from intangible assets
to their U.S. parent corporations. The 1986 act changed the
allocation procedures again to ensure that a greater portion of
income from intangible assets was allocated to U.S. parent
corporations.
Regarding qualified possessions source income (QPSII), the 1982 act
changed the proportion of gross income that a possessions corporation
must earn from the active conduct of a possessions trade or business
in order to qualify for the section 936 credit. The act increased
the proportion from 50 to 65 percent. This, in turn, decreased the
proportion of gross income that a firm could earn from passive
investments and still qualify as a possessions corporation. The 1986
act raised the proportion again so that a firm must derive 75 percent
of its gross income from the active conduct of a trade or business
and no more than 25 percent from passive investments.
The 1986 act also expanded the eligible activities in which QPSII
funds could be invested and still qualify for tax exemption. QPSII
could now be earned on deposits from which the Government Development
Bank and other financial institutions in Puerto Rico made loans for
the acquisition or construction of active business assets or
development projects in qualified Caribbean Basin Initiative
countries.
The 1993 Budget Act limited the section 936 credit as follows. Since
1993 taxpayers were to calculate the credit as under prior law, but
the credit was capped under one of two alternative options selected
by the taxpayer:
The "percentage limitation" option provides for a decreasing credit
equal to a decreasing percentage of the amount computed under
prior law. The percentages were 60 percent in 1994, 55 percent
in 1995, 50 percent in 1996, and 45 percent in 1997. The
percentage was to be 40 percent in 1998 and thereafter.
The "economic-activity limitation" option provides a cap on the
credit equal to the sum of three factors:
The first factor is 60 percent of the firm's wages paid in the
territory, plus allocable employee fringe benefits, with wages
limited for each employee to 85 percent of the amount subject to
Social Security taxes.
The second factor is a specified percentage of the firm's
depreciation deductions for each taxable year. The type of
property defines the applicable percentage: 15 percent for
property with a relatively short recovery period, 40 percent for
property with a medium-length recovery period, and 65 percent
for assets with a long recovery period.
The third factor, which applies only to firms that do not use
the 50-percent profit-split method of income allocation, is a
portion of the income taxes paid to the territorial government.
The taxes included, however, cannot exceed a 9 percent effective
tax rate.
The Small Business Job Protection Act of 1996 repealed the tax credit
for taxable years after December 31, 1995. However, the act provides
transition rules under which a corporation that is an existing credit
claimant is eligible to claim credits with respect to possession
business income for a period lasting through taxable years beginning
before January 1, 2006. For tax years beginning after December 31,
1995, QPSII received or accrued after June 30, 1996, may not be used
in figuring the credit.
For any taxable year beginning after December 31, 1995, and before
January 1, 2006, a corporation that was an existing credit claimant
with respect to Guam, American Samoa, or the Northern Mariana Islands
may continue to determine its credit with respect to such possession
the way it did before the 1996 act. Corporations that were existing
credit claimants with respect to Puerto Rico and the U.S. Virgin
Islands may continue to claim credits, but those credits are to be
subject to income caps.\16 For taxable years beginning in 2006 and
thereafter, the credit with respect to all possessions is to be
eliminated.
--------------------
\16 The new rules for these corporations are provided in section 30A
of the IRC. In order to claim a credit for tax years after 1997,
these corporations must elect the economic-activity limitation option
by tax year 1997. The income cap becomes effective for tax years
beginning after December 31, 2001. Each taxpayer's cap is based on
the average business income that the taxpayer earned in the
possession during a specific base period.
ADDITIONAL DETAILS ON PUERTO
RICO'S ECONOMY
========================================================== Appendix II
Congress has linked the section 936 tax credit to the development of
possessions' economies. The credit is intended to promote investment
by U.S. corporations that leads to increased employment of the
possessions' residents. The intended increase in investment and
employment should also be reflected in the growth of income and
production of the possessions' economies. In this appendix, we
provide additional detail on income, investment, and employment in
Puerto Rico.
DOMESTIC NET INCOME IN PUERTO
RICO
-------------------------------------------------------- Appendix II:1
EMPLOYEE COMPENSATION AND
PROPERTY INCOME
------------------------------------------------------ Appendix II:1.1
Domestic net income is income produced in a country. It is earned by
workers in wages and other compensation and by property owners in
profit and interest. It may also be divided into employee
compensation and property income earned by Puerto Rican residents and
property income earned by nonresidents
As shown in figure II.1, property income has been growing as a share
of net income, and the property income of nonresidents has been
growing as a share of total property income. The share of property
income grew from 45.5 percent of domestic net income in 1982 to 54.6
percent in 1996, and the share of nonresidents in total property
income grew from 67.6 percent to 73.6 percent. The result of these
trends is that the share of domestic net income earned by Puerto
Rican residents from both property and employee compensation declined
from 69.3 percent to 59.8 percent between 1982 and 1996, although
residents' income grew in absolute terms from $16.3 billion to $23.8
billion.
Figure II.1 also shows that these trends were not interrupted by the
changes to the credit in 1993. The share of property income in
domestic net income increased between 1993 and 1996 from 53.4 percent
to 54.6 percent, and the nonresident share of property income
increased from 70.8 percent to 73.6 percent. In contrast, the
residents' share of total net income continued its decline from 62.2
percent to 59.8 percent, although the net income of Puerto Rican
residents grew from $22.6 billion to $23.8 billion.
Figure II.1: Percentage
Distribution of Domestic Net
Income by Employee Compensation
and Property Income, 1982-1996
(See figure in printed
edition.)
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years.
EMPLOYEE COMPENSATION AND
PROPERTY INCOME IN THE
MANUFACTURING SECTOR
------------------------------------------------------ Appendix II:1.2
Most of the tax benefits earned under section 936 have been earned by
corporations in the manufacturing sector.\17 From 1982 through 1996,
both property income and employee compensation increased in the
manufacturing sector. However, employee compensation decreased as a
percentage of total net income in manufacturing. These trends for
the entire period also characterized the period after the changes in
the credit from 1994 through 1996.
As shown in figure II.2, employee compensation in the manufacturing
sector increased from $3.2 billion in 1982 to $3.6 billion in 1996.
As a percentage of domestic net income produced in the manufacturing
sector, employee compensation dropped from 35 percent to 20.2
percent. This trend was also true between 1993 and 1996, when the
share of employee compensation declined from 23 to 20.2 percent.
The growth of property income in the manufacturing sector accounted
for a significant share of the growth in property income in the
overall economy. From 1982 through 1996, property income in Puerto
Rico increased by $11 billion, from $10.7 billion to $21.7 billion.
The increase in property income in the manufacturing sector accounted
for $8.2 billion, or 74.5 percent of the overall increase. Over the
same period, employee compensation in Puerto Rico increased by $5.2
billion, from $12.8 billion to $18 billion. The increase in employee
compensation in the manufacturing sector accounted for about $400
million, or 7.7 percent of the overall increase.
Figure II.2: Employee
Compensation and Property
Income in the Manufacturing
Sector, 1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflator.
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years
The growth of property income in the manufacturing sector continued
to account for a significant share of overall growth in property
income after the 1993 change to the credit. During this period, the
increase in property income in manufacturing accounted for 79.3
percent of overall growth in property income. However, the trend in
employee compensation was different. Between 1993 and 1996, total
employee compensation increased by 6.4 percent, while employee
compensation in manufacturing declined by 2.7 percent.
--------------------
\17 Puerto Rico's tax incentives are limited largely to businesses
operating in the manufacturing or export sectors. Nonmanufacturing
companies that pay the full Puerto Rican income tax can claim a U.S.
foreign tax credit for those taxes paid. Consequently, those
companies receive little, if any, additional U.S. tax reduction
through section 936.
INCOME FROM FOREIGN
INVESTMENT IN PUERTO RICO
------------------------------------------------------ Appendix II:1.3
The increasing role of nonresidents in the growth of the Puerto Rican
economy is indicated by the growth in income from the direct
investments of nonresidents in Puerto Rico. The income from direct
investments is the profit and interest income of companies operating
in Puerto Rico that are owned and controlled by nonresidents. Income
from financial investments is income from other assets owned but not
controlled by nonresidents such as dividends paid by domestic Puerto
Rican companies and interest paid by the Puerto Rican government.
As shown in figure II.3, income from the direct investment of
nonresidents grew between 1982 and 1996, both in total amount and
also as a share of all income from investments owned by nonresidents.
The income from direct investment increased from $7.6 billion in 1982
to $15.7 billion in 1996, growing at an annual rate of 5.3 percent.
This income also increased as a share of total income from
investments owned by nonresidents from 87.4 percent in 1982 to 92
percent in 1996.
Figure II.3 also shows that these trends in income from the
investments of nonresidents continued after the changes to the credit
in 1993. Between 1994 and 1996, income from the direct investment of
nonresidents increased from $14.4 billion to $15.7 billion, and
increased as a share of total income paid to nonresidents from 91.1
to 92 percent.
Figure II.3: Income on
Externally Held Investments,
1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflator.
Source: Puerto Rico Planning Board, Balance of Payments, various
years.
COMPONENTS OF INVESTMENT IN
PUERTO RICO
-------------------------------------------------------- Appendix II:2
Spending on machinery and equipment was the largest component of
investment in Puerto Rico between 1982 and 1996, representing on
average about two-thirds of total private investment spending. Table
II.1 shows that spending on machinery and equipment increased in most
years from about $0.8 billion in 1982 to about $3.2 billion in 1996.
This represented an annual rate of growth of 10 percent. The other
components of private investment grew less rapidly. Spending on the
construction of industrial and commercial buildings grew from about
$0.3 billion in 1982 to $0.9 billion in 1996, for an annual rate of
growth of 8.9 percent. Private spending on housing construction
fluctuated more from year to year than the other components of
investment. Spending on housing construction was about $0.4 billion
in 1982, climbed to $0.72 in 1991, declined to about $0.57 billion in
1992 and 1993, and grew again to $0.97 billion in 1996.
Investment in machinery and equipment declined in 1991 and 1992
following the U.S. economic downturn, but recovered in 1993 and
continued to grow until it declined slightly in 1996. Investment in
industrial and commercial buildings fell in 1990 but grew through
1996. Investment in housing fell in 1992 but grew in every year
thereafter.
Table II.1
Gross Fixed Private Domestic Investment,
1982-1996
(Dollars in millions (constant 1996))
Private Private
Private industrial and investment in
housing commercial machinery and
Year investment investment equipment
---------------------- -------------- -------------- --------------
1982 $405.2 $269.6 $834.5
1983 362.7 221.4 921.7
1984 323.6 375.5 1,115.3
1985 391.5 333.4 1,315.2
1986 406.9 338.9 1,424.1
1987 503.6 462.2 1,669.4
1988 555.9 554.5 1,981.0
1989 580.7 595.3 2,303.9
1990 705.7 575.6 2,418.1
1991 715.9 634.2 2,395.0
1992 569.8 676.0 2,388.3
1993 574.0 775.2 2,762.0
1994 660.6 804.7 2,914.1
1995 750.9 809.7 3,224.0
1996 973.6 884.0 3,187.6
----------------------------------------------------------------------
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflators for investment.
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years
EMPLOYMENT BY ECONOMIC SECTOR
IN PUERTO RICO
-------------------------------------------------------- Appendix II:3
As Table II.2 shows, total nonagricultural employment in
establishments in Puerto Rico grew from 660,000 in 1982 to 945,000 in
1996. Over this period, the share of manufacturing employment
declined from 22.4 percent of the total to 16.3 percent and the share
of government employment fell from 36.2 percent to 32.6 percent.
Manufacturing employment has actually fallen in absolute terms since
its peak in 1990. In contrast, the share of employment in the retail
trade sector rose from 12 percent to 15.8 percent and the share of
the nonfinancial service sector rose from 13.3 percent to 18.5
percent.
Table II.2
Employment by Major Industrial Sector,
1982-1996
((Numbers in thousands of persons))
198 198 198 198 198 198 198 198 199 199 199 199 199 199 199
2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
----- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
================================================================================
Total 660 635 665 695 709 746 796 832 841 838 844 862 879 912 945
Manuf 148 141 148 149 149 148 154 156 157 152 152 151 150 153 154
actu
ring
Minin a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/
g\a
Const 29 23 25 28 26 32 39 44 44 44 46 47 45 46 52
ruct
ion
Trade 110 107 112 119 124 132 142 149 154 156 155 163 171 181 188
Whole 31 29 30 31 30 32 35 36 37 37 37 37 36 38 40
sale
Retai 79 77 83 89 94 100 107 113 117 119 118 126 135 143 149
l
Finan 29 28 29 30 32 34 36 37 37 37 37 39 41 42 44
ce,
Insu
ranc
e &
Real
Esta
te
Trans 15 15 16 16 16 17 18 19 20 21 21 22 23 23 24
port
atio
n,
Comm
unic
atio
n
and
othe
r
Publ
ic
Util
itie
s
Servi 88 85 88 96 100 108 117 126 132 134 139 147 157 164 175
ce
Gover 239 236 246 257 261 273 289 301 296 291 293 292 291 304 308
nment
--------------------------------------------------------------------------------
\a Totals for mining (a/) represent numbers of less than 2,000.
Source: Puerto Rico Planning Board, Economic Report to the Governor,
various years
INFORMATION ON ECONOMIC
DEVELOPMENT ADMINISTRATION
PROMOTIONS
========================================================= Appendix III
The Economic Development Administration (EDA)/ Industrial Development
Company of Puerto Rico (PRIDCO) promotes investments by local and
overseas businesses. Generally, but not always, the investments
promoted by EDA receive tax exemptions under Puerto Rican tax
incentive legislation. According to an EDA official, EDA promotions
may also receive cash grants from the government of Puerto Rico.
The EDA promotions, which are negotiated between EDA and the business
owners, include commitments to hire and pay employees and to invest
capital in specified amounts. According to an EDA official, for
promotions that receive tax incentives, EDA must be convinced that
the commitments are realistic and made in good faith. For promotions
involving cash grants, the businesses must comply with the employment
commitment before the cash is disbursed.
To receive a tax exemption, the business owners must submit an
application to the Office of Industrial Tax Exemption. This office
may recommend a grant of exemption to the Secretary of State for
promotions that also receive the endorsement of EDA, the Treasury
Department, the Environmental Office, and the municipality in which
the business is located. The tax exemption may be granted to local
and nonlocal promotions. Promotions are considered nonlocal if they
receive at least 50 percent of the capital invested from the United
States or other foreign countries.
PROMOTIONS OF THE ECONOMIC
DEVELOPMENT ADMINISTRATION
------------------------------------------------------- Appendix III:1
EDA promoted a total 2,856 businesses between 1982 and 1996. Local
promotions accounted for 1,731, or 61 percent of the total
promotions. As shown in figure III.1, local promotions outnumbered
nonlocal promotions in nearly every year between 1982 and 1996. The
number of local promotions reached their highest level of 167
businesses promoted in 1987. The number of nonlocal promotions was
greatest in 1988 when 120 businesses were promoted by EDA. Nonlocal
promotions declined in most years after 1988 while local promotions
declined in most years after 1990.
The trend of generally declining promotions continued after the 1993
changes in the tax credit. Local promotions numbered 84 in 1995, the
smallest number of promotions since the 81 businesses promoted by EDA
in 1982, but increased to 112 promotions in 1996. Nonlocal
promotions numbered 33 in 1994, the smallest number of nonlocal
promotion for any year between 1982 and 1996. Nonlocal promotions
increased to 49 in 1995 but declined again to 44 in 1996.
Figure III.1: The Number of
Local and Nonlocal Promotions
by the Economic Development
Administration, 1982-1996
(See figure in printed
edition.)
Source: Economic Development Administration of Puerto Rico.
EMPLOYMENT COMMITTED TO
ECONOMIC DEVELOPMENT
ADMINISTRATION PROMOTIONS
------------------------------------------------------- Appendix III:2
Businesses promoted by EDA committed to hiring a total of 173,195
employees between 1982 and 1996. Nonlocal businesses committed to
hiring 111,206 employees, or 64 percent of the total committed
employment. As shown in figure III.2, employment committed by
nonlocal businesses exceeded commitments by local businesses in
nearly every year between 1982 and 1996. The employment commitment
of nonlocal businesses reached its highest level of 13,596 in 1988
and declined in most years thereafter. The employment commitment of
local businesses reached its highest level of 7,787 in 1986 and
declined in most years after 1986.
The trend of generally declining employment commitments continued
after the 1993 changes in the credit for both local and nonlocal
businesses. Nonlocal businesses committed to hire 2,367 employees in
1994, the smallest commitment by nonlocal businesses of any year
between 1982 and 1996. Their employment commitment increased to
6,218 in 1995 but fell again in 1996 to 3,785. Local businesses
committed to hire 1,636 employees in 1995, the smallest commitment by
local businesses in any year between 1982 and 1996. Their commitment
increased in 1996 to 2,913.
Figure III.2: Employment
Committed to Local and Nonlocal
Promotions, 1982-1996
(See figure in printed
edition.)
Source: Economic Development Administration of Puerto Rico.
PAYROLL AND INVESTMENT
COMMITTED TO ECONOMIC
DEVELOPMENT ADMINISTRATION
PROMOTIONS
------------------------------------------------------- Appendix III:3
Between 1982 and 1996, businesses promoted by EDA committed to
investing $2.6 billion in Puerto Rico and committed to paying
employees $2.2 billion. Nonlocal businesses made the largest share
of this commitment by investing $2.2 billion, or 85 percent of the
total investment commitment, and by paying employees $1.5 billion, or
67 percent of the total payroll commitment.
Investment committed to local and nonlocal promotions was greatest
during this period in the late 1980s and early 1990s. Figure III.3
shows that committed investment for nonlocal promotions reached its
highest level in 1990 at $363.5 million, and that committed
investment for local promotions which reached its highest level of
$48.6 million in 1990. Investment committed to nonlocal promotions
continued a generally declining trend in 1994 immediately after the
changes in the credit but began to rise again in 1995 and 1996.
Investment committed to nonlocal promotions fell to $19.9 million in
1994, the smallest amount of committed investment for any year
between 1982 and 1996, but increased to $108.4 million in 1995 and
$105.7 million in 1996. After increasing to $38.3 million in 1993,
investment committed to local promotions generally declined in
subsequent years.
Figure III.3: Investment
Committed to Local and Nonlocal
Promotions, 1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflator for investment in machinery and equipment.
Source: Economic Development Administration of Puerto Rico.
Payroll committed to nonlocal promotions was generally greater in the
1980s than the 1990s. Figure III.4 shows that committed payroll for
nonlocal promotions reached its highest level in 1988 at $193.5
million. Committed payroll for local promotions reached its highest
level in 1986 at $104.8 million. Payroll committed to nonlocal
promotions continued a declining trend in 1994 immediately after the
changes to the credit when it fell to $28.2 million, the smallest
amount committed for any year between 1982 and 1996. However,
committed payroll increased to $77.4 million in 1995, and fell again
to $46.7 million in 1996. Payroll committed to local promotions
declined in 1994 and 1995, but increased again in 1996.
As a comparison of figures III.3 and III.4 shows, nonlocal promotions
tended to be more capital intensive than the local promotions.
Between 1982 and 1996, the ratio of committed payroll to investment
was 1.8 to 1 in local promotions while this ratio was 0.64 to 1 in
nonlocal promotions.
Figure III.4: Payroll
Committed to Local and Nonlocal
Promotions, 1982-1996
(See figure in printed
edition.)
Note: Figures were adjusted for inflation using the Puerto Rican GNP
deflator.
Source: Economic Development Administration of Puerto Rico.
(See figure in printed edition.)Appendix IV
COMMENTS FROM THE SECRETARY OF THE
TREASURY OF PUERTO RICO
========================================================= Appendix III
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)Appendix V
COMMENTS FROM THE COMMISSIONER OF
FINANCIAL INSTITUTIONS
========================================================= Appendix III
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)Appendix VI
COMMENTS FROM THE PUERTO RICO
PLANNING BOARD
========================================================= Appendix III
(See figure in printed edition.)Now on p.4.
(See figure in printed edition.)
(See figure in printed edition.)Appendix VII
COMMENTS FROM THE ECONOMIC
DEVELOPMENT ADMINISTRATION
========================================================= Appendix III
MAJOR CONTRIBUTORS TO THIS REPORT
======================================================== Appendix VIII
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
James A. Wozny, Assistant Director, Tax Policy and Administration
Issues
Kevin E. Daly, Economist-in-Charge
Eric Hall, Computer Specialist
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