Puerto Rico Needs to Return to Pro-Growth Measures

In 2006, Puerto Rico began an economic decline that continues to this day.

Stephen J. Entin from the Tax Foundation provides the details.

The U.S. used to offer its possessions like Puerto Rico favorable tax treatment to encourage economic growth and job creation. No longer. The Revenue Act of 1921 largely exempted possession-sourced income from federal tax. Section 936 was added to the code in the Tax Reform Act of 1976 to revise the taxation of income in U.S. possessions. According to the Senate Finance Committee report on the 1976 Act, the purpose of the provision was to “assist the U.S. possessions in obtaining employment producing investments by U.S. corporations.”

Section 936 continued the practice of making business income from the possessions largely exempt from federal income tax, but listed certain conditions. A U.S. firm would receive a tax credit on dividends received from its possessions subsidiary (repatriated earnings) equal to the U.S. tax otherwise due if the firm had, over the three years prior to the tax year, derived 80% of its income from the possession and at least 75% of the income was from a trade or active business. According to the GAO, from 1983 to 1993, about 99% of the affected income was from Puerto Rico.

The U.S. pharmaceutical industry in particular made use of the provision, creating tens of thousands of jobs on the island either directly, or through local suppliers, and by boosting island incomes and consumption.

The pharmaceutical industry based intellectual property on the island, as well as manufacturing operations, in what could be described as an early version of the modern “patent box” concept.

The Tax Reform Act of 1996 phased out section 936 over ten years, ending it completely in 2006, and with it went the dividend deduction. This made Puerto Rican subsidiaries of U.S. businesses subject to the same world-wide U.S. corporate income tax as other offshore subsidiaries of U.S. businesses. It ended the island’s favored tax status relative to any other global location.

In 2006, Puerto Rico began an economic decline that continues to this day.