The CHAIRMAN. Thank you very much, Mr. Garrido.

Next we have Mr. Miguel Ferrer, President of the Securities Industry Association of Puerto Rico.

STATEMENT OF MIGUEL A. FERRER, PRESIDENT, SECURITIES INDUSTRY ASSOCIATION, PUERTO RICO, ACCOMPANIED BY JOSE GONZALEZ, SECURITIES INDUSTRY ASSOCIATION; AND JORE MIRANDA, SECURITIES INDUSTRY ASSOCIATION

Mr. FERRER. Mr. Chairman, Senators, my name is Miguel Antonio Ferrer. I am here representing the Securities Industry Association of Puerto Rico, which is composed of the many securities firms with presence in Puerto Rico.

With me to help with questions that may arise is Mr. Jose Ramon Gonzalez.

We welcome having this opportunity to focus your attention on two matters of economic significance that have not been offered sufficient attention up to now. Please allow me to briefly read from the statement previously submitted to you.

The Securities Industry Association of Puerto Rico maintains that, irrespective of political status considerations, section 936 of the U.S. Internal Revenue Code should be preserved as long as possible, since the corporations operating under this section are of fundamental importance to Puerto Rico's present and future economic wellbeing. Section 936, coupled with the Puerto Rico Industrial Incentives Acts, constitute the most cost-effective economic development benefit the United States currently provides Puerto Rico.

The Securities Industry Association of Puerto Rico believes that any alteration of section 936 would cause severe dislocations in the existing economic structure of Puerto Rico, and as such should be rejected. It should be noted that this section has already been altered twice, once in 1982 through the TEFRA Act, and later in 1985. In both instances the uncertainty caused by revisions in the section proved damaging to investment in Puerto Rico and raised the costs of locating in Puerto Rico for 936 corporations. The Association believes that the limitations placed on income due to intangibles by TEFRA and the trimming of benefits from investment income effected in 1985 were sufficient to address the concerns of the U.S. Treasury and the Congress, and that preservation of this section as presently established is essential. The operation of section 936 has been the subject of much analysis, almost since the section's enactment in 1976. This presentation makes use of previous studies on the impact of section 936, particularly the recently finished study commissioned by the Puerto Rico Bankers Association.

The purpose of this presentation is to elaborate on the following points:

One. Since the enactment of the section in 1976, 936 manufacturing and financial activities have given life to local industry and capital markets, which currently are the backbone of investment activities benefiting Puerto Rico and the Caribbean Basin.

Two. Section 936 accelerated the development in Puerto Rico of high-technology manufacturing precisely at the time when rising labor costs and other factors were eroding Puerto Rico's competitive edge in light, labor-intensive manufacturing.

Three. Approximately $15 billion that 936 companies keep invested in Puerto Rico are the island's most valuable source of capital and have played a crucial role in the development of a modern and sophisticated financial system.

Four. Funds invested by 936 companies in Puerto Rico have also been crucial in supporting socially-stabilizing public sector programs and have provided a relatively low-cost source of financing for government investment in development oriented projects.

Five. The cost-benefit analyses of the operation of section 936 indicate that the benefits to Puerto Rico are substantially higher than the costs to the U.S. Treasury, so that the section is a cost-effective instrument for promoting economic development in the island.

Puerto Rico's present and future level of economic development depends critically on the preservation of section 936.

I will also touch now on the second matter on hand, which is a supplementary statement made in our statement to you.

The Securities Industry Association of Puerto Rico believes strongly that any consideration to modify Puerto Rico's existing political status should take into account the tax attributes at the time of issuance of Puerto Rico's securities and other types of financings so that significant economic value is not needlessly destroyed, and Puerto Rico's ability to finance its future economic development is not impaired.

There are several types of securities which would be adversely affected by change in political status and should be considered separately.

First, Puerto Rico municipal bonds that qualify under section 103 of the U.S. Internal Revenue code are by virtue of the Puerto Rico federal relationship and predecessor legislation exempt from federal, state and local taxation. This allows the commonwealth of Puerto Rico to market the bonds to U.S. investors on a nationwide basis and to price these bonds at rates significantly lower than would otherwise be achievable, given Puerto Rico's credit rating.

Any change to the Puerto Rico federal relationship that adversely alters the so-called triple tax exemption of Puerto Rico municipal bonds-for example, eliminating the state and local tax exemption that is generally not a feature of the U.S. municipal bonds, except within the issuing jurisdiction, would materially reduce the value of these securities of between 4 to 5 percent of the outstanding principal amount.

This would represent a loss in value to U.S. mainland holders of these securities of between $400-$500 million of face value of the commonwealth's outstanding public debt as of December 31, 1988, and a corresponding loss to the IRS through the capital loss provisions.

In addition to issuing municipal bonds that qualify under section 103 of the U.S. Internal Revenue Code for federal tax exemption, Puerto Rico also issues other types of obligations exempt from Puerto Rico income taxation for sales exclusively to residents of Puerto Rico, the proceeds of which are used for the funding of the capital improvement programs of public corporations such as Puerto Rico Telephone Authority, the Puerto Rican Industrial Development Company, and other public and private sector economic development projects which for various technical reasons do not qualify for federal tax exemption under section 103 of the code.

These bonds are sold on the basis of Puerto Rico tax exemption, and the current tax status of Puerto Rico residents under federal law which provides that residents of Puerto Rico are generally exempt from U.S. income taxation on their income from Puerto Rico sources.

The imposition of federal income taxation upon residents of Puerto Rico who have invested in good faith in these securities could devalue approximately 10 percent or about $100 million of the outstanding value of these securities.

Finally, the commonwealth of Puerto Rico has for years provided support for the housing market by providing Puerto Rico tax exemption for certain types of mortgages and mortgage backed securities relating to housing in Puerto Rico. This has allowed Puerto

Rico housing markets to remain strong when other markets have faltered and has reduced the effective cost of housing in Puerto Rico, allowing for affordable housing programs sponsored by the commonwealth.

This favorable tax treatment once again has been based on the fact that under the current relationship between the U.S. and Puerto Rico, residents of the commonwealth are not subject to federal income taxation on their Puerto Rico source income.

In this case, the imposition of federal income taxation upon residents of Puerto Rico could result in a market devaluation of these securities equal to approximately 8 percent of the outstanding face amount of the securities or somewhere approximately $150-$185 million.

For the reasons stated above, the Securities Industry Association of Puerto Rico strongly feels that irrespective of political status considerations, the particular tax status applicable of the date of issuance to any Puerto Rico securities or any other type of financing should be effectively grandfathered. Failure to do so would destroy significant investor wealth both in Puerto Rico and in the United States without achieving any meaningful objective for either jurisdiction.

Beyond the potentially negative retrospective effects on investor assets described above, the Security Industry Association of Puerto Rico would like to point out that the elimination or curtailment of the current tax attributes of Puerto Rico securities would result in a significant increase in the cost of capital for public and private sector economic development projects and infrastructure in Puerto Rico and would, therefore, materially adversely affect the future growth of the local economy.

Thank you very much.

[The prepared statement of Mr. Ferrer follows:]

Statement by the Securities Industry Association of Puerto Rico Before the U.S. Senate Committee on Energy and Natural Resources on S. 710, S. 711 and S.712

San Juan, Puerto Rico

June 16-19th, 1989

The Securities Industry Association of Puerto Rico maintains that, irrespective of political status considerations, Section 936 of the U.S. Internal Revenue Code should be preserved as long as possible, since the corporations operating under this Section are of fundamental importance to Puerto Rico's present and future economic well being. Section 936, coupled with the Puerto Rico Industrial Incentives Acts, constitute the most cost-effective economic development benefit the United States currently provides Puerto Rico.

The Securities Industry Association of Puerto Rico believes that any alteration of Section 936 would cause severe dislocations in the existing economic structure of Puerto Rico, and as such should be rejected. It should be noted that the Section has already been altered twice, once in 1982 through TEFRA (the Tax Equity and Fiscal Responsibility Act), and later in 1985. In both instances the uncertainty caused by revisions in the Section proved damaging to investment in Puerto Rico and raised the costs of locating in Puerto Rico for 936 corporations. The Association believes that the limitations placed on income due to intangibles by TEFRA and the trimming of benefits from investment income effected in 1985 were sufficient to address the concerns of the U.S. Treasury and the Congress, and that preservation of the Section as presently established is essential.

The operation of Section 936 has been the subject of much analysis almost since the section's enactment in 1976. This presentation makes use of previous studies on the impact of Section 936, particularly the recently finished study commissioned by the Puerto Rico Bankers Association.

The purpose of the presentation is to elaborate on the following points:

• Since the enactment of the Section in 1976, 936 manufacturing and financial activities have given life to local industry and capital markets, which currently are the backbone of investment activities benefiting Puerto Rico and the Caribbean Basin.

• Section 936 accelerated the development in Puerto Rico of hightechnology manufacturing precisely at a time when rising labor costs and other factors were eroding Puerto Rico's competitive edge in light, labor-intensive manufacturing.

The approximately $15 billion that 936 companies keep invested in Puerto Rico are the Island's most valuable source of capital and have played a crucial role in the development of a modern and sophisticated financial system.

• Funds invested by 936 companies in Puerto Rico have also been crucial in supporting socially-stabilizing public sector programs and have provided a relatively low-cost source of financing for government investment in development oriented projects.

• Cost-benefit analyses of the operation of Section 936 indicate that the benefits to Puerto Rico are substantially higher than the costs to