COMMONWEALTH OF PUERTO RICO OFFICE OF THE GOVERNOR February 13, 1985 The Honorable James Baker Dear Mr. Secretary: You inherited a proposal to repeal section 936 of the Internal Revenue Code and replace it with a temporary, partial and diminishing wage credit for Puerto Rico. I urge you to reject this dangerous experiment promptly and decisively, for it and its very pendency are as inimical to U. S. interests as they are to Puerto Rico. Only two years have elapsed since section 936 was amended to eliminate perceived abuses. The final amendment was championed by the Treasury, the Government of Puerto Rico, and U. S. companies operating in the Commonwealth. Just prior to the enactment of this amendment, I am advised, President Reagan personally expressed misgivings about modifying section 936. It was the understanding of all parties directly involved in working out the language of the amendment that section 936 would not be revisited until there was an opportunity to assess the effectiveness of these changes in curbing the abuses they addressed and until there was full consultation with the Commonwealth. Investments were made and tax incentives granted by the Commonwealth of Puerto Rico in reliance upon this understanding, and there has not yet been the experience required to support a fair assessment of the amendment. Nor has the Commonwealth been consulted. Repealing section 936 will not increase U.S. revenues because the 936 companies will avail themselves of the opportunity to defer, possibly indefinitely, recognition of foreign source income. Many will move their manufacturing operations immediately to foreign sites. Absent section 936, costs are lower there because such sites are not burdened with the U. S. minimum wage, the Jones Act, and other federal regulations. The limited wage credit proposed by Treasury would not begin to overcome these significant cost differentials that the United States imposes on manufacturing operations in Puerto Rico. Some companies may remain in Puerto Rico, at least temporarily until they recoup larger sunk investments, but these firms will not pay additional U. S. taxes, either. Instead, they will be taxed by Puerto Rico and thereby earn foreign tax credits. As the Treasury Report recognizes, they, too, may defer indefinitely recognition of income earned in Puerto Rico. In all likelihood, repeal of section 936 will add to the federal deficit as it will surely damage Puerto Rico. Unemployment here --currently 200-- already in nearly three times higher than the U. S. mainland average. But it would reach truly crisis levels with the demise of section 936. Puerto Rico would require additional transfer payments from the federal Treasury. Migration will become a floodgate with thousands of Puerto Ricans who are unwilling to go back to a subsistence economy moving to the already congested job markets in mainland states in search of work. The net effect will be senseless human dislocation and suffering and an avoidable increased drain on the federal treasury. Furthermore, the earnings of 936 companies also account for more than 41% of total commercial deposits in Puerto Rican banks. Repeal, therefore, could lead to bank failures and significant federal insurance payments. The repeal of section 936 will cause unprecedented social and political unrest in Puerto Rico. It will also engender grave concern elsewhere in the Caribbean and in Central and Latin America where the infliction of such damage upon United States citizens will not go unnoticed by those who understand that they have even less of a claim to U. S. concern. This would prejudice in Puerto Rico and the Caribbean, the national security interests of the United States. In one of my first decisions as Governor I directed that section 936 funds on deposit in the Puerto Rico Government Development Bank be used to assist the United States in securing its national security objectives in the region. For example, Puerto Rico may offer 100% financing of a Puerto Rican plant in return for a company's commitment. to finance a second plant elsewhere in the Caribbean to manufacture components for the Puerto Rican facility. Repeal of section 936, of course, would deprive us of the resources we are prepared to devote to this concept that has been so well received throughout the Caribbean. The Treasury proposal has had a chilling effect on new investment in Puerto Rico. The proposal must be promptly discarded so that its damaging effects upon our efforts to develop our economy and assist the Caribbean cease as promptly as possible. I look forward to meeting with you to discuss this most critical matter. Cordially Rafael Hernández-Colón COMMONWEALTH OF PUERTO RICO OFFICE OF THE GOVERNOR RAFAEL HERNANDEZ COLON March 12, 1985 85-05553 The Honorable James A. Baker, III Secretary of the Treasury Main Treasury, Room 3330 15th Street & Pennsylvania Avenue, N.W. Dear Mr. Secretary: The Commonwealth's enclosed Report on section 936 of the Internal Revenue Code explains why the proposal for its repeal would be a disaster for the United States and Puerto Rico: 1. The repeal of section 936 would not raise additional revenues. The tax reform study's billion dollar revenue estimates depend on the assumption that 936 companies would not use alternative means of sheltering their income. This assumption is unrealistic since the Treasury's tax reform plan would allow these companies to defer U.S. taxation of their profits for an indefinite period by reincorporating in jurisdictions outside the United States (including Puerto Rico). "The repeal of [section 936] would not result in a large gain to the U.S. Treasury... to the extent 936 companies take advantage of this tax-saving opportunity. 1/ 2. Repeal of section 936 would add to the federal deficit. Additional welfare benefits would have to be paid to laid off employees of section 936 firms as well as to employees terminated by companies that supply those firms with goods and services. Migration to the mainland would increase and add to the United States welfare burden. Puerto Rico's 3.2 million people are United States citizens and thus are free to join the 2 million Puerto Ricans already living on the mainland where welfare benefits are higher and there is no "cap" on the Treasury's responsibility for such payments. 1/ Department of the Treasury, The Operation and Effect of La Fortaleza, San Juan, Puerto Rico 00901 3. Section 936 is the essential tool for economic development in Puerto Rico. Thousands of jobs have been lost in the past decade because of the imposition of the federal minimum wage, substantial reductions in protective tariffs, and steep increases in energy and other costs. Section 936 has enabled Puerto Rico to replace many of these lost jobs with better ones in high technology companies. Consequently, Puerto Rico's unemployment, while high, increased at a much lesser rate during this difficult period than unemployment in the United States, Great Britain, or Japan. Puerto Rico's ability to continue attracting new investment depends entirely on the retention of section 936. 4. The proposed wage credit is not an adequate substitute for section 936. The cost of hiring the lowest paid manufacturing workers in Puerto Rico would still be over $2 an hour even after the credit, while plentiful labor is available in neighboring Caribbean countries for as little as 33 cents an hour. 5. It is not true that section 936 "costs the United States more per worker $22,000 than the average compensation received per worker -- $14,210. A compelling case can be made that it costs the United States nothing to forego taxes on profits that would not exist but for section 936. Furthermore, after correcting for errors in the Treasury study assumptions, the so-called "cost" of section 936 turns out to be $10,726 per worker, at most, while the real benefits per worker amount to $48,885. 6. Treasury has no legitimate cause to revise the ground rules for taxing business investments in Puerto Rico to which it recently agreed. Section 936 was amended by the Tax Equity and Fiscal Responsibility Act of 1982 less than three years ago to correct perceived abuses in the allocation of income between section 936 companies and affiliated U.S. firms. These amendments, painstakingly negotiated by Treasury, the Government of Puerto Rico, and other interested parties, were supposed to stabilize the uncertain tax environment in Puerto Rico. Shortly after TEFRA was enacted, the Assistant Secretary of the Treasury (Tax Policy), wrote to Senator Robert Dole, Chairman of the Senate Finance Committee, that it would be premature to change the rules at least until Treasury had data from which to determine whether the TEFRA amendments were working. Such data are not yet available. 7. Repeal of section 936 would undermine the Administration's Caribbean policy and jeopardize vital security Interests of the United States. The thrust of U.S. policy In the Caribbean, embodied in the President's Caribbean Basin Initiative ("CBI"), is to protect United States security interests by fostering a stable democratic region through economic development. Repeal of section 936 would have the contrary effect of jeopardizing a critically important naval base by destabilizing the most important democracy in the region. It also would prevent the Government of Puerto Rico from pursuing its announced goal of using the leverage of section 936 funds to encourage development of "twin plants" in Puerto Rico and CBI countries. In view of the overwhelming arguments against repeal of section 936, and the serious damage that the very pendency of this proposal is currently inflicting on the United States and Puerto Rico, I urge you to announce promptly the withdrawal of that proposal from any tax reform plan that may be sponsored by the Treasury. Sincerely yours, RHC Raffel Hernander Colón COMMONWEALTH OF PUERTO RICO 1 OFFICE OF THE GOVERNOR RAFAEL HERNANDEZ COLON April 9, 1985 The Honorable James A. Baker, 111 Secretary of the Treasury Main Treasury, Room 3330 15th Street & Pennsylvania Ave., N.W. Washington, D.C. 20220 Dear Mr. Secretary: I deeply appreciated the opportunity to meet with you regarding Section 936. Commonwealth officials also had a valuable follow-up meeting with Steven R. Lainoff, the International Tax Counsel of the Treasury, and members of his staff. I was gratified to hear from you that Treasury does not intend to propose any change in the tax laws that would affect Puerto Rico adversely. We are agreed that tax incentives are necessary to induce business to invest in Puerto Rico. The question you posed is whether the operation of the existing incentive could be improved. We believe that Section 936 is working well and extremely beneficially for Puerto Rico. According to a new Citibank economic study, the preliminary results of which only have become available this week, the Section 936 companies now account for 60 percent of manufacturing employment in Puerto Rico, 73 percent of gross domestic product in manufacturing, and 25 percent of total salaries paid in all sectors of the Puerto Rican economy. Employment in Section 936 companies since 1977 has grown at a faster rate than in trade, construction, agriculture, or public utilities. During this period, although overall employment in Puerto Rico grew only .81. employment in the Section 936 companies increased nearly 21, while the non-936 companies suffered a net loss of about 1.58. Taking into account both increases in productivity and employment over this same period --1977-84 -the Section 936 companies have achieved a faster growth than any other sector of the Puerto Rican economy. We must be very careful not to jeopardize this success, for any change in the tax laws that would decrease the incentive of these companies to remain in and expand their investments in Puerto Rico would have an enormous adverse impact on our economy, and, as we explained in our March 12, 1985 report to you, this damage to our economy inevitably would add to the United States deficit. its 1 reaffirm my commitment, expressed to you in our meeting of March 12th, that our Government will cooperate with Treasury to eliminate any abuses. From discussions with Mr. Lainoff, it appears that the principal concerns with Section 936 are complexity and apprehension that there still may be the transfer to Puerto Rico of intangibles income which is properly attributable to the United States. As to the complexity point, I note that we are dealing with a limited number of sophisticated corporate taxpayers that accept the complexity of the provision as a fair trade off for its effectiveness as an incentive. On the question of intangibles income, Mr. Lainoff acknowledged that the recent TEFRA amendments to Section 936 addressed this problem and that the Treasury does not yet have sufficient data fromTM which to draw any definitive conclusions about its success. I am sure you will agree that we should wait until this information on the results of the last major overhaul of the statute is availa ble, carefully analyzed, and we are afforded an opportunity to comment upon these results before you conclude that the risks to Puerto Rico and the United States of revisiting this provision" are fully warranted. If the data show that section 936--as amended is being used to shelter income that should properly be subject to tax, we will be happy to work out appropriate sponses with you and your staff that will eliminate the abuses hout destroying the Section 936 incentive on which our economy ends. |