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Executive Summary

The Puerto Rican govt. has earmarked $200 mil. derived from section 936 investments for application to construction projects which could ease the nation's high unemployment rate, Puerto Rican Governor Rafael Hernandez Colon noted in July 11 testimony before the House Ways & Means Cmte. The hearing is part of a series on the Reagan Administration's tax simplification plan. Pointing out that a promise to use section 936 funds to cut unemployment in Puerto Rico was one of the key factors leading to his election last November, Hernandez Colon said that one example could be investment of section 936 funds in the construction industry. "We will create a $200 mil. Mortgage Trust which will finance, at lower than market rates, 5,000 housing units per year, thereby solving our housing problem, and revitalizing our much-depressed construction industry. Through this vehicle we will create 18,000 new jobs, a 23% increase in construction employment," he said. Hernandez Colon said that the creation of mortgage trust fund is one example of the ways in which his govt. intends to directly use funds derived from section 936 tax savings to solve economic problems facing Puerto Rico. The governor declared that "the pool of $7 bil. of 936 earnings should be directed not as much to the financial system but towards real investment through private industry in our economy." Another proposed use of section 936 funds, Hernandez Colon said, is the "twin-planting" concept that would tie new manufacturing facilities in Puerto Rico to complementary sites in other Caribbean locations. "I committed the money deposited in the Puerto Rican Government Development Bank as a consequence of section 936 and our own law -- - a total of approximately $700 mil. -- to a strategy of shared regional development for the Caribbean. Financing was made available on favorable terms, for new plants in Puerto Rico to corporations ready to invest their own funds in 'twin plants' on other Caribbean islands." Hernandez Colon specifically noted twin-plant discussions he has had with three other Caribbean nations: Grenada, Jamaica and Dominica. He noted that "four pharmaceutical firms are prepared to create new plants and jobs in Grenada if we succeed in preserving section 936." Those firms were previously identified as SmithKline Beckman, Abbott, Schering-Plough and Johnson & Johnson ("The Pink Sheet" May 6, p. 3). "We now have commitments from 21 section 936 corporations to make new investments in Puerto Rico and complementary new investments elsewhere in the Caribbean Basin and Central America, provided section 936 remains unchanged," Hernandez Colon said. In testimony later in the session, PMA President Gerald Mossinghoff noted that 16 of the 21 section 936 companies who have committed to the twin-plant concept are PMA members. Hernandez Colon and other Puerto Rican officials, as well as representatives of U.S. industry doing business in Puerto Rico under the section 936 provision, testified that the Treasury Dept.'s proposal to modify section 936 would have a strongly adverse effect on the island nation's economy. The details of how the Puerto Rican govt. plans to use section 936-generated money to stimulate the island's economy counters Treasury Dept. criticism that 936 funds are not being utilized to increase employment. The witnesses maintained that the administration's reasoning behind its proposal to replace the current income based system with a wage-based system is founded on erroneous assumptions. Antonio Colorado, administrator of Puerto Rico's Economic Development Administration, noted that "Treasury asserts that section 936 does not create jobs because the level of employment in Puerto Rico has not increased significantly in the past 10 years as it did during the 1960's. The fact is that section 936 created thousands of new jobs in the past 10 years, mainly in the high technology industries. Employment in high-tech companies has been growing at an average rate of 4.6% per year since 1976. . .Employment in pharmaceuticals has grown by over 7.7% per year." Colorado added that "Treasury's estimate of the number of jobs created by section 936 also disregards completely 150,000 or more employees in Puerto Rico who supply goods and services to section 936 companies and their employees and whose jobs are therefore attributable to and dependent on the continuation of section 936." Questioned by Ways and Means Cmte. member Barbara Kennelly (D-Conn.), who chaired much of the July 11 session, about the current high unemployment rate on the island, Puerto Rican Congressional Representative Jaime Fuster said that "with section 936, the unemployment rate in Puerto Rico is about 23%. But without section 936, the rate would be 40% or even higher." Colorado attributed the slowdown in the rate of total employment in Puerto Rico in the last 10 years to factors that "no tax incentive could overcome." Among these, he said, were the drastic increase in oil prices during the seventies, "which cost Puerto Rico thousands of jobs in the refinery industry," the "imposition of U.S. minimum wage, environmental and other costly regulatory requirements, and the substantial lowering of U.S. tariffs that previously had protected Puerto Rican goods coming into the U.S." Maintaining that "a wage-credit would drive away many of the high-technology companies -- in chemicals, pharmaceuticals and electronics -- - that have become vital contributors to Puerto Rico's economy," Hernandez Colon said that "Treasury tells us that the high technology jobs its proposal will eliminate in Puerto Rico can be replaced with lower wage jobs in labor-intensive manufacturing. Even this is unlikely [because] wage scales in Puerto Rico are high relative to other developing economies." Puerto Rico "will not be able to attract labor-intensive companies to Puerto Rico by wage-credit that reduces the cost of unskilled labor to 40% of the U.S. minimum wage, or about $1.15 an hour at present rates, when plentiful labor is available in neighboring Caribbean countries for as little as 33 cents an hour," the governor said. Noting estimates of the cost of the section 936 to the U.S. of about $1 bil., and a total employment by section 936 companies of about 90,000, Rep. Guarini (D-NJ) said "that is about $10,000 per person, more than twice the average Puerto Rican's income. What we are really talking about is whether or not there should be some constraints on the pharmaceutical companies. I want to see 936 work. But would we be better off if we gave every one of those 90,000 people $10,000 or $11,000 in cash." Fuster responded, however, that the $1 bil. cost estimate is inaccurate because the figure reflects the tax liability of companies operating in Puerto Rico if there were no section 936 provision. Fuster said that Treasury Dept. calculations assume that business operations would continue unchanged if section 936 is modified. "That is not so," Fuster declared. Commenting on the estimates of the cost of section 936 to the U.S., Colorado said that Treasury Dept. calculations include an assumption that "all section 936 companies in Puerto Rico would pay income tax on to the U.S. on their entire net incomes were it not for section 936. Yet Treasury has conceded that companies would pay no U.S. tax on much of this income even if section 936 did not exist." Colorado also said that the Treasury Dept. estimates "should be reduced by the amount that Treasury would not receive because of companies that would transfer their operations to other companies."

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