by Marty Sullivan
1/28/2014
Puerto Rico’s economy and its government finances are in dire straits. The territory has had eight consecutive years of negative economic growth. Its official unemployment rate is nearly 15 percent. All three credit rating agencies have put its bonds just one notch above junk. Over the last decade, while the total U.S. population grew by 8 percent, the population of Puerto Rico declined by 2 percent. Puerto Ricans are U.S. citizens, and many of them looking for jobs have settled in the central Florida area.
The Obama administration is committed to helping Puerto Rico’s economy get back on its feet — within limits. On October 30, 2009, President Obama signed Executive Order 13517, which expanded the responsibilities of the President’s Task Force on Puerto Rico’s Status to seeking recommendations on economic development. On March 11, 2011, the task force issued a 122-page report with recommendations consisting mostly of streamlining access to existing federal programs, the formation of intragovernmental working groups, and a wish list of legislation that Congress is unlikely to pass. On June 14, 2011, Obama became the first U.S. president to visit Puerto Rico in over 50 years. And in light of Puerto Rico’s continued problems and new concerns about defaults on its bonds, on November 21, 2013, David Agnew, co-chair of the task force, announced that a team of experts from the administration would begin working with Puerto Rican government officials to marshal existing federal resources and help Puerto Rico build its capacity for addressing economic issues.
“I don’t want to convey that that translates into a direct ask for federal direct assistance, because that is not contemplated at this time,” said Mary Miller, Treasury undersecretary for domestic finance, in early November.“These efforts are not a federal intervention,” wrote Agnew when he announced the new team. And just last week a White House spokesperson said: “There is no deep federal assistance being contemplated at this time.”
But here’s a little secret that the powers that be inside and outside government don’t want you to know: The Obama administration has already provided a multibillion-dollar bailout to Puerto Rico. Nobody in the major media outlets has noticed because the issue is highly technical. But let me try to give you a plain English explanation.
In 2010, as part of his conservative agenda to expand Puerto Rico’s economy, Gov. Luis Fortuño wanted to enact large corporate and individual tax cuts. But like for all wannabe tax cutters, it was extremely difficult for him to identify ways to pay for those tax cuts, especially since Puerto Rico’s finances were in terrible shape. The governor appointed a tax reform commission and hired the Washington law firm of Steptoe & Johnson to advise it. Steptoe devised a plan whereby the Puerto Rican government would impose an excise tax on U.S. companies that operated manufacturing facilities in Puerto Rico. The excise tax was first revealed to the public on October 22, 2010. The legislature approved it the following day, and it was signed into law on October 25. The tax was estimated to raise approximately $6 billion over five years.
According to Steptoe & Johnson and the Puerto Rican government, the burden on U.S. companies would be minimal because the new tax paid by U.S. multinationals to Puerto Rico would reduce U.S. taxes by the same amount. For income tax purposes, Puerto Rico is considered a foreign jurisdiction, and foreign taxes can be creditable against U.S. tax. So in effect, the new tax would be paid by the U.S. treasury, not U.S. companies.
The scheme had one serious weakness. There is good reason to question the constitutionality of the tax. That’s because the commerce clause of the U.S. Constitution prohibits a government from taxing businesses operating outside its jurisdiction. Under the new scheme, Puerto Rico was imposing tax on the non-Puerto Rican affiliates of Puerto Rican manufacturers owned by U.S. multinationals. (The U.S.-owned Puerto Rican manufacturers themselves were protected from Puerto Rican tax by agreements signed with the Puerto Rican government.) The taxed affiliates have no physical presence in Puerto Rico. In legal circles and in the courts, there is much debate about whether this type of tax passes constitutional muster. If the tax is not constitutional, it is not creditable against U.S. tax.
Shortly after enactment of the new excise tax, the Puerto Rican government asked Treasury to rule on the creditability of the tax. On March 30, 2010, Notice 2011-29 was issued. In the notice, Treasury provided no legal opinion. The notice stated that the tax was “novel” and that Treasury would have to study it. But it the meantime, U.S. multinationals manufacturing in Puerto Rico could credit the tax until further notice.
Now, three years and billions of dollars later, there has been no further notice. Nor is there any prospect of any. Without committing itself to a legal position, Treasury has provided certainty that has enabled Puerto Rico to raise taxes in the most politically painless way imaginable. That being the case, in February 2013 the government enacted new legislation that extended the tax to 2017 — it was originally scheduled to expire in 2016 — and raised its rate. The revised tax is estimated to raise nearly $2 billion per year, more than 20 percent of Puerto Rico’s general revenue.
A lot of powerful interests like the current situation. They include the government and both major political parties in Puerto Rico, the Obama administration, investors in Puerto Rico’s municipal bonds, and U.S. multinationals that can credit the tax. The only ones on the short end of the stick are U.S. taxpayers, who are footing the bill that they would probably be unwilling to pay if they were ever asked.
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