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Former DNC Chair Howard Dean Rails Against Section 936 Phaseout

By on August 3, 2016

PHILADELPHIA — In an exclusive interview that took place as Caribbean Business reporters were exiting the Wells Fargo Center, after having spoken at the Democratic National Convention last week, former Vermont Gov. Howard Dean told this newspaper that he is for the return of Section 936-type tax breaks.

“I think that we have to bring back those tax breaks that were taken away under [former Puerto Rico Gov.] Pedro Rosselló,” Dean said in reference to the phaseout of Section 936 of the Internal Revenue Code. “I think he allowed it because he was for statehood. I am also for statehood but I believe you need to have something like Section 936, again. There is too much of a gap in economic development. As for Promesa [Puerto Rico Oversight, Management & Economic Stability Act], I am not entirely aware of all of the provisions in the law, but you need economic development.”

Governor Howard Dean during "Democracy for the Senate" Rally and Red Hot Chili Peppers Concert in Santa Monica, CA at Bergamot Station in Santa Monica, California, United States. (Photo by Jean-Paul Aussenard/WireImage)

Gov. Howard Dean during a “Democracy for the Senate” rally in Santa Monica, Calif. (Photo by Jean-Paul Aussenard/WireImage)

Section 936’s incompatibility with statehood, to which Dean referred, traces directly to the Qualified Possession Source Income clause in the measure that establishes clearly that the tax break only extends to possessions or territories—states do not qualify for the tax break. If Puerto Rico were to have become a state, the island would no longer have qualified for the tax benefit. In previous interviews with Caribbean Business, former two-term Gov. Rosselló has responded to criticism over his nano-combativeness pertaining to the elimination of Section 936 with this: “Well, it becomes untenable when the benefits are great for the banks, the benefits were great for the pharmaceuticals, but not for the people. So, if you are coming from the perspective of the banks—sure it is great. If you are coming from the perspective of the large multinational corporations—who would argue against it? And, in fact, they were the major resistance to the change in political status of Puerto Rico.” [See exchange with Rosselló in the print edition.]

Rosselló’s stance is reminiscent of postures taken throughout the history of Puerto Rico’s industrialization by those who oppose tax incentives because they cut into the tax base and offer too few jobs in exchange for huge benefits. “We gave, we gave and we gave but received nothing [referring to enough jobs] in exchange [toward the end],” Amadeo Francis, an economist who was part of the Bootstrap Brigades once told this newspaper during an interview on Puerto Rico’s industrial rise and decline.

However, few can call into question the fact that Puerto Rico’s strategy of tax breaks—even prior to the existence of Section 936—helped grow Puerto Rico’s roster of manufacturing operations from 24 at the end of 1948 to 300 in 1955. In Puerto Rico’s industrial heyday, Puerto Rico’s gross national product quadrupled, surpassing the $2 billion mark; the long line of new factories grew by 160 in 1961 alone, raising the total number of bootstrap plants to 1,030. Importantly, outmigration to the United States, which had been as high as 75,000 in 1953, came down to just over 4,000 people a year.

Again, Puerto Rico’s economy grew based on a strategy underpinned by tax breaks—first came the locally legislated Tax Act of 1948, then congressional action with Section 931, which was then amended to Section 936 in 1972 to include incentives for manufacturing companies to keep their money in Puerto Rico banks to avoid having to pay a tollgate tax. Many observers credit Section 936 as a key driver, taking manufacturing to optimum levels of output. At its peak in 1992, Puerto Rico saw manufacturing output generating nearly 35% of the island’s gross domestic product, while Section 936 helped to bring enormous capital to Puerto Rico banks. In 1996, when the tax incentives were targeted for phaseout, 40% of the funds in Puerto Rico’s banks were Section 936 funds.

Many observers of the current crisis point to the elimination of Section 936 as the epicenter of Puerto Rico’s economic decline. In 2006, the year in which the phaseout of the tax break was complete, Puerto Rico’s economy commenced a slide of apocalyptic proportions. The numbers are harrowing—more than 12,000 businesses have shuttered, more than 250,000 jobs have been lost and more than 500,000 people have outmigrated.

This mass exodus has prompted a growing chorus of voices on the Hill and in the capitol realm who admit that perhaps it was a mistake to have throttled the tax incentives without anything in exchange. In a roundtable with Martin O’Malley, former governor of Maryland, which took place during the Democratic National Convention, Caribbean Business asked him point blank if it was a mistake to do away with Section 936. “I think that it was a mistake. Not to understand the impact that it would have and not to have a plan after it was allowed to sunset,” O’Malley said after a speech he delivered before the Puerto Rico delegates at the Desmond Hotel in Malvern, Penn. “Our federal government is pretty dysfunctional and no one bore the brunt of that inability to compromise than Puerto Rico has these last several years. So we probably need an economic strategy unique to the island.”

Among the many measures that are being discussed are extending Section 243A of the Internal Revenue Code to Puerto Rico, which provides deductions on dividends received by corporations. Also on the table as a possible vehicle to attract capital to Puerto Rico is proposed Section 933A, which would grant tax credits for 40% of Puerto Rico source income to qualified corporations.

Editor’s note: The following is an excerpt from a previous interview with former Puerto Rico Gov. Pedro Rosselló.

CB: It wouldn’t be possible to have Section 936 if we were a state.

Pedro Rosselló: Because it only applies to possessions. In other words, if you are independent, it doesn’t apply; if you are a state, it doesn’t apply. It only applies to territories, and that is why there was such a strong sector supporting Section 936 because of the extraordinary benefits that they received.

CB: Wouldn’t it have made sense not to throw out the baby with the bathwater, because you were trying to obtain Section 30-A wage credits to replace Section 936 or parity under “Hillarycare” as a quid pro quo, but we got neither?

Rosselló: First of all, the last point that you bring up, the healthcare reform under former President Clinton, never occurred. It never happened. It was way before the midterms. In addition to that, the other point that you make—we tried to get some benefits that were for the people. Section 936 was based on the concept of a tax credit against your earnings—your earnings would be tax-free. We tried to change the definition of those credits so they would be based on the costs of labor—of the salaries that they provided; that benefit would have gone to the workers directly, not to the corporations. That was one of the benefits we were trying to tie the benefits to. So it was different from Section 936. The other element that we tried to tie down was the element of research and innovation, and that there would be credits for whatever research and innovation was conducted here in Puerto Rico.

So Section 30-A was an attempt to redefine what the credits were granted for. Before, with Section 936, it was open benefits based on whatever earnings you made. We sought to tie it to salaries, labor costs, to training of the labor force and to research and development.

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