Tax Analysts Blog

The Obama Administration's Backdoor Bailout of Puerto Rico

Posted on Jan 27, 2014

Puerto Rico’s economy and its government finances are in dire straits. The territory has had eight consecutive years of negative economic growth. Its official unemployment rate is nearly 15 percent. All three credit rating agencies have put its bonds just one notch above junk. Over the last decade, while the total U.S. population grew by 8 percent, the population of Puerto Rico declined by 2 percent. Puerto Ricans are U.S. citizens, and many of them looking for jobs have settled in the central Florida area.

The Obama administration is committed to helping Puerto Rico’s economy get back on its feet — within limits. On October 30, 2009, President Obama signed Executive Order 13517, which expanded the responsibilities of the President’s Task Force on Puerto Rico’s Status to seeking recommendations on economic development. On March 11, 2011, the task force issued a 122-page report with recommendations consisting mostly of streamlining access to existing federal programs, the formation of intragovernmental working groups, and a wish list of legislation that Congress is unlikely to pass. On June 14, 2011, Obama became the first U.S. president to visit Puerto Rico in over 50 years. And in light of Puerto Rico’s continued problems and new concerns about defaults on its bonds, on November 21, 2013, David Agnew, co-chair of the task force, announced that a team of experts from the administration would begin working with Puerto Rican government officials to marshal existing federal resources and help Puerto Rico build its capacity for addressing economic issues.

“I don’t want to convey that that translates into a direct ask for federal direct assistance, because that is not contemplated at this time,” said Mary Miller, Treasury undersecretary for domestic finance, in early November. “These efforts are not a federal intervention,” wrote Agnew when he announced the new team. And just last week a White House spokesperson said: "There is no deep federal assistance being contemplated at this time."

But here’s a little secret that the powers that be inside and outside government don’t want you to know: The Obama administration has already provided a multibillion-dollar bailout to Puerto Rico. Nobody in the major media outlets has noticed because the issue is highly technical. But let me try to give you a plain English explanation.

In 2010, as part of his conservative agenda to expand Puerto Rico's economy, Gov. Luis Fortuño wanted to enact large corporate and individual tax cuts. But like for all wannabe tax cutters, it was extremely difficult for him to identify ways to pay for those tax cuts, especially since Puerto Rico's finances were in terrible shape. The governor appointed a tax reform commission and hired the Washington law firm of Steptoe & Johnson to advise it. Steptoe devised a plan whereby the Puerto Rican government would impose an excise tax on U.S. companies that operated manufacturing facilities in Puerto Rico. The excise tax was first revealed to the public on October 22, 2010. The legislature approved it the following day, and it was signed into law on October 25. The tax was estimated to raise approximately $6 billion over five years.

According to Steptoe & Johnson and the Puerto Rican government, the burden on U.S. companies would be minimal because the new tax paid by U.S. multinationals to Puerto Rico would reduce U.S. taxes by the same amount. For income tax purposes, Puerto Rico is considered a foreign jurisdiction, and foreign taxes can be creditable against U.S. tax. So in effect, the new tax would be paid by the U.S. treasury, not U.S. companies.

The scheme had one serious weakness. There is good reason to question the constitutionality of the tax. That’s because the commerce clause of the U.S. Constitution prohibits a government from taxing businesses operating outside its jurisdiction. Under the new scheme, Puerto Rico was imposing tax on the non-Puerto Rican affiliates of Puerto Rican manufacturers owned by U.S. multinationals. (The U.S.-owned Puerto Rican manufacturers themselves were protected from Puerto Rican tax by agreements signed with the Puerto Rican government.) The taxed affiliates have no physical presence in Puerto Rico. In legal circles and in the courts, there is much debate about whether this type of tax passes constitutional muster. If the tax is not constitutional, it is not creditable against U.S. tax.

Shortly after enactment of the new excise tax, the Puerto Rican government asked Treasury to rule on the creditability of the tax. On March 30, 2011, Notice 2011-29 was issued. In the notice, Treasury provided no legal opinion. The notice stated that the tax was “novel” and that Treasury would have to study it. But it the meantime, U.S. multinationals manufacturing in Puerto Rico could credit the tax until further notice.

Now, three years and billions of dollars later, there has been no further notice. Nor is there any prospect of any. Without committing itself to a legal position, Treasury has provided certainty that has enabled Puerto Rico to raise taxes in the most politically painless way imaginable. That being the case, in February 2013 the government enacted new legislation that extended the tax to 2017 -- it was originally scheduled to expire in 2016 -- and raised its rate. The revised tax is estimated to raise nearly $2 billion per year, more than 20 percent of Puerto Rico’s general revenue.

A lot of powerful interests like the current situation. They include the government and both major political parties in Puerto Rico, the Obama administration, investors in Puerto Rico’s municipal bonds, and U.S. multinationals that can credit the tax. The only ones on the short end of the stick are U.S. taxpayers, who are footing the bill that they would probably be unwilling to pay if they were ever asked.

(You can read the in depth analysis behind this blog post here.)

Read Comments (15)

emsig beobachterJan 27, 2014

Would there be an adverse impact on U.S. taxpayers if Puerto Rico were to
default? This plan may be less expensive for U.S. taxpayers than allowing the
Puerto Rican government to default.

Christopher BerginJan 27, 2014

Marty, great post. Once again, you have done the country a valuable service.
Thank you.

Cate LongJan 27, 2014

Hi Martin:

Good post. I covered this issue back in June from the fiscal perspective. The
expansion of this tax has helped PR avoid default so far.

I think this issue will be addressed when/if Puerto Rico has to restructure
their debts.

Would love to see the Steptoe letter. BTW Luis Fortuno (ex PR governor) went to
work at Steptoe after leaving office.

A. ToroJan 27, 2014

J. Buono, adding to your 4th point, the cabotage law imposed on P.R. under the
Jones Act restricts our trade with the U.S. mainland only. This being said, we
cannot insert P.R. into the global economy. Is this an advantage for the U.S.
or for the COLONY?

Samael reyasonJan 27, 2014

Somos 4 millones de habitantes salen mejor dándole 5 millones a cada uno de
ellos personalmente y no dándoselo al gobierno de Puerto Rico q son unos
ladrones por favor saquen a los políticos de Puerto Rico métanlos presos y
gobiernen ustedes para que fiscalicen mejor el dinero

Juan BuonoJan 27, 2014

1] many American investors own P.R. bonds ; so they don't want P.R. to default
on them
2] Everything sold in P.R. [food, clothes etc. ] comes from the U.S. and is
sold by American firms like Walmart, Sears, Walgreens , Home Depot, Mc Donalds
,etc. So any money given to P.R. goes right back to the U.S.
3] Many Americans do not want more Puertoricans on the mainland ; so if the
economy improves in P.R. more will stay put.
4] All products that come to P.R. are transported by American ships which are
more expensive than ships from other countries ; so everything is more
expensive in P.R. than in the mainland.

Charlie VJan 27, 2014

Triple-exempt municipal bonds from Puerto Rico have enjoyed great popularity
from the institutional investors in the US for the past 30 years. 70 billion
dollars in debt later, PR is facing a scrutiny and questions of whether it can
continue borrowing money, making payments on its bond obligations and have a
viable economy after 8 years of uninterruptued recession.

Joe CJan 27, 2014

About J. Buono's #3 point, I don't think racism and/or xenophobic issues need
to be addressed at this time. We need to be united in our Nation, and PRicans
are US Citizens as you do.

vivian darkbloomJan 27, 2014

It is scandalous that the IRS would fail to issue an opinion on an issue of
such great importance. While this case may present novel and complex issues,
there is no excuse for not issuing a determination in the three years the IRS's
talented team of lawyers have had to ponder them.

The clear implication is that this "non-decision" reflects the fact that no
well considered opinion could justify the creditability of this excise tax.
The "non-decision"is simply a political one by an agency that is supposed to
not be engaged in politics.

Thanks Martin Sullivan for bringing his to our attention. I hope the
mainstream press follows up with more reporting.

vivian darkbloomJan 28, 2014

Another thing: That clearly political "non-decision" bears the signature of
the author and his phone number at the IRS, but this person obviously did not
act alone. One can well imagine the extensive discussions among some top folks
at the IRS as to how to achieve the political objective without admitting the
law was being ignored. A number of folks had to be complicit in this.

Now, to the *correct* usage of the term "whistleblower". With the number of
people at the IRS who must be aware of this, it is truly disappointing that
someone has not come forward to reveal what was really going on behind the
scenes. The simple fact is that being a whistleblower is far less lucrative
for those lawyers than remaining in good graces within the IRS and maintaining
the chance of a subsequent partnership at Steptoe and Johnson or another first
tier law firm. We need to remember this one the next time someone wants to wax
poetic about the "public service" of our IRS officials.

vivian darkbloomJan 28, 2014

New York Times headline today:

"“Whenever I can take steps without legislation to expand opportunity for more
American families, that’s what I’m going to do.”

The idea that one does not need Congress to achieve one's objectives has been a
key one in this administration and it certainly does not stop at "expanding
opportunity" for American families. And don't kid yourself that that does not
mean bending or breaking the law and/or the Constitution to do it. The idea
here that one's self-perceived moral superiority noble goals justify doing an
end-around Congress and our democratic system is a hallmark of the
administration. This IRS "non-decision" is just one example among many. If
Puerto Rico needs a bailout, Congress should approve it and the people should
know.

This is just one page right out of the book of Castro, Mugabe and Chavez.

amt buffJan 28, 2014

"The 'non-decision' is simply a political one by an agency that is supposed to
not be engaged in politics."

Correct. Once upon a time tax law was mostly about efficiently raising revenue.
How quaint.

Creation of tax law has become much more partisan over recent decades.
Efficiency is way down the list of priorities.

The name of the game is to extract maximum tax from the supporters of one party
and minimum tax from the supporters of the other party.

Now enforcement is also becoming partisan, with fidelity to the law and
equitable treatment of taxpayers moving down in priority. Tax administrators
are becoming political actors in their own right.

Tax revolt was once a protest against the size and scope of taxation. In the
near future, tax revolt will become a partisan act. Tax revolt will mirror
partisan creation and enforcement of tax law to the benefit of one party and
the detriment of the other.

This will not end well. Future generations will marvel at how blind otherwise
intelligent Americans have been to the poisoning effect of partisanship in
taxation.

edmund dantesJan 28, 2014

I second Ms. Darkbloom's motion. What's really sad is that the NYTimes and the
Democrats in Congress are applauding Obama's extra-legal ways! Someone once
said that if you scratch a liberal you uncover a fascist, and I guess that's
true.

Abdiel RiveraJan 29, 2014

Mr. Martin Sullivan then we demand:
- To get reimbursed all PR has pay under the Jones Act, specifically, "Cabotage
Law".

We want retrospective, Rent for all the military bases in PR. Also, We want our
two island, Culebra and Vieques to be clean, from all the military training US
Marine-Navy did in PR (like US is not big enough, or why didn't use Hawaii ?)

We want compensation for all the drugs (contraceptive, cancer experiment, among
others) and weapon (Orange agent for instance) test with our people.

We want compensation for all the live taken as a consequence of World War I,
II, Vietnam and Korea.

The Point is: US is not giving us nothing. They own us more than that.

John chayoteeJan 31, 2014

The only that can be palatable should be to offer medicare and medicnaid fund
parity becouse PR contribute equal to SS and meficare than whatever US
citizens. This money can save thousand and half or pr budget to cover health
universal insurance. But this savings mudt be redirected to infraestructure
project under federal overview to avoid typical latin behavior.....

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