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PUERTO RICAN STATEHOOD COULD CAUSE SEC. 936 FIRMS TO REDUCE INVESTMENTS

Executive Summary

PUERTO RICAN STATEHOOD COULD CAUSE SEC. 936 FIRMS TO REDUCE INVESTMENTS in the island but not necessarily to relocate operations, Congressional Budget Office Director Robert Reischauer maintained in April 26 testimony before the Senate Finance Committee. Reischauer said the loss of 936 tax benefits if Puerto Rico's status were changed to that of a state or an independent republic would "more likely" cause firms "to reduce investment" rather than to incur the costs of relocation. Reischauer pointed out that "for many firms, location in a low-tax foreign location could offer a significant tax advantage over Puerto Rico under statehood." Reischauer was discussing a CBO analysis of the potential effects of legislation (S 712) to provide a referendum for Puerto Rican citizens to choose statehood, independence or continued commonwealth status. The bill would eliminate the 936 tax benefit if Puerto Rico becomes independent and would phase it out over six years if the island becomes a state ("The Pink Sheet" Dec. 11, T&G-9). "Losing that tax advantage would leave Puerto Rico at a cost disadvantage relative to other locations," Reischauer explained. "The after-tax rate of return on existing investments on the island would fall. Firms that found themselves earning less than a normal after-tax rate of return would be likely to curtail investment there or relocate their production." CBO calculated that under statehood, "the reported after-tax rate of return would fall by about" 11 percentage points for pharmaceutical firms. The Bush Administration supports S 712. Treasury Department International Tax Counsel Philip Morrison testified: "the Administration believes that the Puerto Rican people should be given an opportunity to express their will in a manner that recognizes the historic and fundamentally political nature of their decision of self-determination." Sen. Moynihan (D-N.Y.) agreed. The issue, Moynihan said, is "civic, not economic." Congress "must act" quickly to allow Puerto Ricans to decide whether they "wish to become Americans" or "to retain a separate identity." The "explosive nature" of the island's original relationship to the U.S. is that "it became an American colony" as "the spoil of a colonial war." Finance Committee Chairman Bentsen (D-Texas) and New Jersey Sen. Bradley (D) expressed a reluctance to act on S 712 without more complete information on the ramifications of each possible outcome of a referendum. Bradley suggested that a Supreme Court declaratory judgment should be obtained to determine whether the proposal to continue, though gradually reduce, 936 if the island becomes a state is a violation of the Constitution's requirement that states be treated uniformly by the federal government. Asking Morrison why the Administration does not think it needs "a declaratory judgment from the Supreme Court," Bradley said: "I would want to know with a little more authority than a Justice Department lawyer" that the 936 phase out is constitutional. Justice Department opinions "have been wrong," the New Jersey Democrat said, and "there are a lot of dollars involved." Morrison testified that the Administration estimates statehood would add $2-$3 bil. to the federal deficit between 1992 and 1995 and that it would be financed through adjustments in other federal programs. Bradley replied that if he were a Puerto Rican citizen voting on the referendum, he "would want to have the Administration on the record as to where the money is going to come from so that I could be sure I was going to get the money." HHS Assistant Secretary for Planning and Evaluation Martin Gerry testified that his department's annual expenditures of $2.7 bil. in benefits for Puerto Rico would be increased by $1.6 bil. in 1995 and by $3 bil. if the island were to become a state. "Most of this increase is attributable to changes in Medicaid and Supplemental Security Income" benefits, Gerry said. The increases would represent "about 80% of the total federal expenditure increases," he added.
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