It's Time to Reform the Puerto Rico Tax Credit

REPUBLICANS and Democrats disagree on how to balance the budget. There is common ground, however, regarding the need to reduce unnecessary subsidies to highly profitable corporations. How can Washington propose to drastically change all aspects of the federal government, yet leave corporate tax subsidies untouched?

One of the greatest examples of corporate welfare is Section 936 of the Internal Revenue Code, which gives corporations tax credits for opening and operating facilities in Puerto Rico. The United States Treasury, the Congressional Budget Office (CBO), and the General Accounting Office (GAO) have conducted studies showing that Section 936 costs taxpayers billions of dollars each year without providing much assistance to Puerto Rico.

Unfortunately, most of these tax credits are used by capital-intensive firms to transfer patents and income to their Puerto Rican subsidiaries. For the last 10 years, a majority of Section 936 companies have averaged an approximate $100,000 tax credit per $20,000 paid to each employee. It would be cheaper for the Treasury to write a $70,000 check directly to each Section 936 employee.

Since the 1970s, the US government has lost more than $480 billion because of Section 936. What have been the results? Unemployment in Puerto Rico has remained chronically high, between 15 and 17 percent. Additionally, the manufacturing sector on the island provides approximately 101,000 jobs - the same as 20 years ago.

Failed reform effort

In 1993, President Clinton recommended changing Section 936 to a 60 percent wage credit. During that year, however, Section 936 companies spent millions of dollars lobbying Washington to protect these subsidies; ultimately, the 1993 Budget Reconciliation Act gradually reduced the level of the income credit over five years. A new Section 936 provision was also created based on economic activity and wages.

With a 60 percent limit for the income credit in 1994, the total tax savings per company should have decreased approximately 40 percent from 1993. However, of the 12 largest companies on the island, six actually increased their tax savings under the income credit, and five of them are still averaging over $100,000 in credits per employee. How can it make sense that one company with 5,600 employees averaged a $23,036 tax credit per worker while another company, with only 980 employees, averaged a $187,755 credit per worker? Despite the 1993 changes, 936 still remains a method for major corporations to play with their books and increase their profits. Under a plan we propose, the company that showed the greatest tax savings in 1994 would have a tax savings of approximately $55 million in 1995 instead of $247 million, as it did in 1994.

Both Republicans and Democrats in Congress realize the abuses of Section 936 and propose phasing it out over 10 years. The Budget Reconciliation Act savings from this phaseout will be an estimated $3.7 billion. Regardless, over this 10-year period, Section 936 companies will still cost the Treasury and taxpayers more than $25 billion.

To their credit, Puerto Rican Gov. Pedro Rosello and Resident Commissioner Carlos Romero Barcelo also realize the flaws of 936 and have proposed a new wage-credit section. Unfortunately, both officials want this credit to continue for an unspecified period of time, which does not result in any real savings for the Treasury.

Phase out credit faster

President Clinton's budget proposal also recognizes the abuses of the 936 income credit. The Clinton plan calls for a five-year phaseout of the income credit, while establishing a permanent wage credit as well as providing full Medicaid benefits to all Puerto Rican residents. But the president's plan does not reduce the deficit, since his proposal uses the phaseout to pay for the Medicaid benefits.

Our experience in Congress shows that five or 10 years for this type of income credit is simply too long. A fair compromise would be to phase out the income credit in two years. Using Governor Rosello's plan as a model, we can give Puerto Rico a real wage credit for seven years. Puerto Rico must realize that even the wage credit is not permanent and eventually the island will have to stand on its own.

Another idea is to give a 60 percent wage credit for existing jobs and an 80 percent credit for new jobs. We estimate that this accelerated phaseout plan will save another $4 billion to $5 billion to help balance the budget over a seven-year time frame. With part of these additional savings, Congress can also work with the Puerto Rican government to promote economic development in a more cost-efficient way. Everyone wins; even corporations using the income credit will benefit under a new wage-credit method, although to a lesser degree.

Whenever the president and Congress reach a budget agreement, the final language on Section 936 will be a true test of their commitment to balancing the federal budget. The US can truly help the Puerto Rican people and their leaders create new jobs and an overall better quality of life while at the same time saving the Treasury more than $5 billion by phasing out Section 936. We hope that, during these intense budget negotiations, common sense will prevail, and the president and congressional leaders will agree to phase out this abused tax credit.