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Why tax reform could be (really) bad for Puerto Rico

Why tax reform could be (really) bad for Puerto Rico

Posted by Juan Gavasa on March 09, 2015

There are not many issues that congressional Republicans and President Obama see eye to eye on. But when it comes to changing how the tax code treats foreign profits of U.S. corporations, there seems to be room for agreement. For Puerto Rico, the U.S. territory mired in a years-long economic slump, the prospect of corporate tax reform is cause for concern.

For decades, Puerto Rico has relied on its unique place in the U.S. tax code to foster economic development. Puerto Rico is part of the United States, yet for tax purposes most subsidiaries of U.S. firms operating there are organized as controlled foreign corporations. That means they do not pay taxes to the U.S. Treasury as long as earnings remain in Puerto Rico.

The special tax treatment has made Puerto Rico a favored destination for manufacturers. Even after the elimination of another more generous tax break led many manufacturers to leave in recent years, the island still has some 70 pharmaceutical plants. The once agrarian island also has a high concentration of medical device makers, as well as biotech plants.

In all, manufacturing accounts for nearly half the island’s economic output and more than one in 12 jobs. Those jobs pay an average of $39,000 a year — a princely sum in a territory with a nearly 14 percent unemployment rate and where 40 percent of the people who are working earn only the $7.25 an hour federal minimum wage.

But that could change if Congress acts on tax reform — an issue that has been much discussed in recent years, even if action has been scant. In his most recent budget proposal released last month, Obama proposed having U.S. firms pay a 14 percent tax on some $2 trillion in overseas earnings, while paying a 19 percent minimum tax on future profits. The idea behind the proposal is to fix a corporate tax code that many economists agree discourages investment in the United States with its 35 percent nominal federal rate (plus state rates that average over 6 percent), while leaving loopholes for big firms to use sophisticated accounting strategies to shift profits to foreign tax havens.

Puerto Rico would almost certainly lose tens of thousands of jobs under that proposition, unless the island is exempted from those tax changes — which analysts say is not necessarily a lock if tax reform moves forward. “The impression is that multinational corporations are evading taxes” and taking jobs out of the United States, said José Villamil, an economist and president of Estudios Técnicos. “But jobs in Puerto Rico are already held by U.S. citizens."

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