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Puerto Rico feeling sting as job tax break phases out
The Miami Herald / June 7, 1998

By Larry Luxner

WASHINGTON -- Two years after Congress voted to phase out tax incentives for companies investing in Puerto Rico, some of the island's top manufacturing employers have pulled out, laying off thousands of factory workers -- and few new companies are coming in to replace them.

Last month, Motorola Inc. announced it would shut its beeper factory in Vega Baja, just west of San Juan. The plant's 1,500 workers will lose their jobs or be transferred before June 30, the official shut down date. The company will shift production to Boynton Beach, Fla., according to Motorola official Miguel Pereira.

"There are some efficiency factors," Pereira said in a press statement. "Boynton Beach has the advantage of having both the capability to design new products and manufacture them."

Other expected major plant closures this year include Next Level Systems Inc., which will close its factory in Barceloneta, leaving 900 jobless; brassiere manufacturer Maidenform Inc., which plans to dismiss 800; Hoesch Marion Roussel, which will leave 230 jobless by year's end, and Roche Products, which is laying off 190 pharmaceutical workers.

Politicians and private executives alike are blaming this disturbing trend on the loss of Section 936, a federal tax program that has helped create hundreds of thousands of jobs on this Caribbean island.

Under a provision of the Small Business Job Protection Act, signed into law by President Clinton in October 1996, corporate tax breaks for all existing factories operating under 936 will disappear within a decade, with no federal incentives whatsoever for new investments. As such, Section 936, which was sacrificed to offset anticipated federal revenue losses from tax breaks given to small businesses -- and to help Congress pay for the minimum-wage hike -- is effectively eliminated retroactively to Dec. 31, 1995, for any business not already claiming it.

For all other companies, the law continues a phase-out process begun in 1993, providing a new cap on the credit beginning in 2002, and abolishing it altogether for active business income by Jan. 1, 2006, meaning that existing 936 companies are grandfathered in for the next eight and a half years.

Clinton himself has never been happy about eliminating the program. Recognizing the damage it could do to Puerto Rico, the president asked Congress immediately after signing the bill to "act to ensure that the incentive for economic activity remains in effect" to prevent multinationals from fleeing Puerto Rico once the tax credit is history.

Yet it may be awfully hard to stop them -- especially when countries like the Dominican Republic and Mexico can offer similar benefits at a fraction of the labor cost.

"Since 936 was modified in 1993, even before the repeal, there's been a significant dropoff in the number of new companies investing in Puerto Rico," says Peter Holmes, spokesman for the Puerto Rico-USA Foundation in Washington. "Companies already there are hanging on. Some, like Intel, have increased employment, which has helped offset the loss in textile jobs. But in terms of new people coming in, there has been a tremendous dropoff in new, non-local business coming to Puerto Rico."

It's hard for outsiders to appreciate just how crucial Section 936 has become to the economy of Puerto Rico, an island of 3.8 million people captured by U.S. forces in the 1898 Spanish-American War and made into a U.S. Commonwealth in 1952.

An outgrowth of President Truman's postwar Operation Bootstrap, Section 936 since the mid-1970s had exempted manufacturers from paying federal income tax on profits earned by their subsidiaries in Puerto Rico. That drew some 2,000 factories to the island, where in the peak year of 1989 they employed 161,000 people in the production and export of everything from Hanes underwear to Microsoft floppy disks -- all for a hungry American market.

Since then, manufacturing employment has fallen to around 148,000, though U.S. subsidies and direct factory investment have given the island a per-capita income of around $7,500. Though this is far less than the poorest U.S. state, Mississippi, it tops most other Caribbean islands and ranks Puerto Rico the highest in Latin America.

Antonio J. Colorado Jr., executive director of Caribbean/Latin American Action, a Washington-based lobby, said Wednesday that "you're always going to have plants closing. But with more competition from Mexico and other countries, it's going to be more difficult for Puerto Rico. The problem is that no new companies are coming, so nobody's closing the gap."

He adds that "the companies that are closing now aren't closing because of 936. They're enjoying the tax benefits, because their grandfathered in. Yet they can't expand under the exemption. The fact is, they may not want to put large amounts of money in something that'll end up to be non-competitive."

According to a recent Price Waterhouse study commissioned by the Puerto Rico Federal Affairs Administration in Washington, the island's current manufacturing decline is "a logical consequence" of the federal repeal of 936.

Between 1980 and 1993, says the study, employment commitments averaged nearly 8,500 jobs per year. Between 1994 and 1997, these commitments jumped over 40% to only 4,765 jobs per year. The report also points to a 3% decline in manufacturing employment during the first five months of 1997.

Colorado -- a former Puerto Rico resident commissioner in Washington and the island's ex-secretary of state -- spent most of his time in office trying to save 936 from congressmen like Sen. David Pryor (D-Arkansas) who viewed the tax clause as "corporate welfare" and wanted to axe it. At one time, Colorado was so closely linked with the struggle that his Puerto Rican license plate read "AJC-936" and newspaper articles referred to him as "Mr. 936."

But in the end, charges the politician, "Congress didn't take 936 away. Puerto Rico gave 936 away." That's a bitter reference to speeches by former Gov. Carlos Romero Barcelo -- the man who later defeated Colorado for the resident commissioner's job -- who argued that 936 amounted to "corporate welfare" and that Puerto Rico would be better off economically as the 51st state of the union.

Kal Wagenheim, publisher of Caribbean Update and an expert on the island's status question, says Congress got a mixed message and saw the issue as partisan politics.

"Had Puerto Rico's two major parties argued that 936 couldn't be touched, that it was critical to the island's economy," he says, "I think Congress would have looked elsewhere for sources of money to balance the budget."

Politics aside, says Colorado, U.S. executives rarely consider the island these days when thinking about where to put their next factory.

"Nobody looking at Puerto Rico as a place to invest. People looking from outside see no stability, so it's no longer an incentive," he says, noting that in 1989, 1990 and 1991, Puerto Rico ranked first in the world in terms of political risk -- even higher than the United States. This year's ranking puts the island at No. 22.

Holmes, of the Puerto Rico-USA Foundation, says he's seeing a similar trend.

"In the days when 936 was whole, Puerto Rico was such an attractive site for investment that when multinational corporations had problems requiring a company-wide reorganization, their Puerto Rican factories were never in the equation. It was sort of held separately because it was a great moneymaker thanks to the tax benefits," said Holmes, whose organization represents 50 or 60 large U.S. multinationals that represent 60% of the Section 936 investment in Puerto Rico.

"Now, with the loss of 936," he says, "there's no uniqueness attached to the Puerto Rican operation. So when there's a market change, the Puerto Rican subsidiary is factored into the decision-making process."

To be fair, not everyone is pulling out, and some companies are even expanding to take advantage of 936 as long as they can. Pharmaceutical giant G.D. Searle, for example, just announced plans to invest $200 million in a factory expansion that'll create 700 new jobs.

In order to remain competitive, some U.S. firms -- including Searle -- have given up their 936 status and have reorganized as Controlled Foreign Corporations (CFCs), which puts them outside the U.S. tax code until they remit profits back to stateside headquarters. CFCs, says Holmes, "provide a deferred tax benefit that can be put off for many years if the company is global and can invest its Puerto Rican profits in properties around the globe."

But, says Holmes, "it's a little too early to gauge the impact. Companies still have until 2005, and they're in the process of making longer-range business decisions, some of which haven't been implemented yet. Companies are certainly going to try to stay in Puerto Rico if they possibly can, because many of them have substantial capital invesments there. The question is whether those companies will grow or contract."

Puerto Rico's current pro-statehood governor, Pedro Rossello, is hoping to offset the loss of 936 by moving to lower the island's effective tax rate on overseas corporations from 14% to around 7% or less.

But Wagenheim says the reduction of local taxes won't help much because once 936 is gone, U.S. manufacturers would still have to pay federal tax -- something over which Puerto Rico has no control.

"Companies are not going to Puerto Rico because of local tax incentives. That's not why they went there in the first place," he says. "No matter what Puerto Rico does, you can't get away from the fact that you're still subject to the federal minimum wage. It's still a good place to do business, but there are productive workers everywhere."

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