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This article is from the
November/December 2015 issue.

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Puerto Rico’s Colonial Economy

Dear Dr. Dollar:

It seems like Puerto Rico’s economic and financial mess came out of nowhere. Until recently, there wasn’t much about Puerto Rico in the press, but what there was seemed to portray things as fine, with a generous amount of funds going to the island from Washington. Sometimes, Puerto Rico was held up as a model for economic development. So where did the current mess come from? —Janet Sands, Chicago, Ill.

BY ARTHUR MACEWAN | November/December 2015

Puerto Rico is a colony of the United States. Colonial status, with some exceptions, is not a good basis for economic progress.

Recently, the details of the Puerto Rican economic mess, and especially the financial crisis, have become almost daily fodder for the U.S. press. Yet, the island’s colonial status and the economic impact of that status, which lie at the foundation of the current debacle, have been largely ignored.

Puerto Rico, like other colonies, has been administered in the interests of the “mother country.” For example, for many years, a provision of the U.S. tax code, Section 936, let U.S. firms operate on the island without incurring taxes on their Puerto Rican profits (as long as those profits were not moved back to the states). This program was portrayed as a job creator for Puerto Rico. Yet the principal beneficiaries were U.S. firms—especially pharmaceutical firms. When this tax provision was in full-force in the late 1980s and early 1990s, it cost the U.S. government on average more than $3.00 in lost tax revenue for each $1.00 in wages paid in Puerto Rico by the pharmaceuticals. (What’s more, the pharmaceuticals, while they did produce in Puerto Rico, also located many of their patents with their Puerto Rican subsidiaries, thus avoiding taxes on the profits from these patents.)

Puerto Ricans are U.S. citizens, but residents of the island have no voting representatives in Congress and do not participate in presidential elections. The Puerto Rican government does have a good deal of autonomy, but is ultimately under U.S. law. And without voting representatives in Congress, Puerto Rico is unable to obtain equal status in federal programs or full inclusion in important legislation. A good example of the latter, which has become especially important in the ongoing financial crisis, is that U.S. law excludes the Puerto Rican government from declaring bankruptcy, an option available to U.S. states and their cities.

It is often asserted that the U.S. government provides “generous” benefits to Puerto Rico. Perhaps the largest federal payment to Puerto Ricans is Social Security. Yet Puerto Ricans on the island pay Social Security taxes just like residents of states and the District of Columbia. Likewise, Puerto Ricans pay Medicare taxes just like residents of the states, but, unlike residents of the states, their Medicare benefits are capped at a lower level. Among the important programs from which residents of Puerto Rico are excluded, a big one is the earned income tax credit (EITC). As a result, a two-parent, two-child family in Puerto Rico earning $25,000 a year ends up, after federal taxes and credits, with about $6,000 less income than a family in the states with the same earnings and family structure.

Opponents of extending the EITC to residents of Puerto Rico argue that they should not get the EITC because they are not liable for federal income taxes. Yet many EITC recipients in the states pay no federal income taxes simply because their incomes are so low (e.g., the family in the above example). Moreover, the EITC was established to offset the burden on low-income families of Social Security and Medicare taxes, which Puerto Rico residents do pay, and to reduce poverty, of which Puerto Ricans have more than their share.

If Puerto Rico gets “generous” benefits from Washington, several states are treated more generously. In particular, if states are ranked in terms of their “net receipts” per capita from the federal government—that is, funds received from the federal government minus federal taxes—in a typical year about one-third of the states rank above Puerto Rico (though the number varies somewhat in different years). In 2010, for example, West Virginia received $8,365 per capita more in federal expenditures than were paid from the state in federal taxes; Kentucky $7,812 more; Vermont $6,713 more; and Alaska and Hawaii topped the list with $11,123 per capita and $10,733 per capita more respectively from the federal government than they paid to the federal government. That year Puerto Rico received on net $4,697 per capita.

Beyond these particular disadvantages of colonial status, Puerto Rico suffers from a pervaisive condition of “dependency.” In setting economic policy, the Puerto Rican government has continually looked beyond the island, to investments by U.S. firms and favors from Washington. As James Dietz has usefully summed up the situation in his 2003 book Puerto Rico: Negotiating Development and Change: “...Puerto Rico’s strategy of development lacked a focus on the systematic support or fostering of local entrepreneurs and local sources of finance.” As a consequence “the central role of domestic entrepreneurs, skilled workers and technological progress that underlies sustained economic progress” has been weaker in Puerto Rico than in sovereign nations where sustained economic progress has proceeded more rapidly. Moreover, government policy and decisions by investors tend to be short-sighted, failing to build the foundation for long-term economic progress. The poor condition of the public schools and the weak physical infrastructure are examples of the consequences.

All of these factors have retarded the Puerto Rican economy for decades. The island did experience a burst of economic activity in the post-World War II period, heavily dependent on low-wage labor, privileged access to the U.S. market, and federal and local tax breaks for U.S. firms. As wages rose and other parts of the world gained access to the U.S. market, the economy faltered. From the mid-1970s into the early 2000s, Puerto Rico lost economic ground compared to the states.

The severe recession that then emerged in 2006 and that Puerto Rico has suffered under for the past decade, only partially attenuated by heavy government borrowing on the bond market, was an outcome to be expected from the economy’s long-term weakness and, in fact, was precipitated by that heavy government borrowing.

By 2006, the Puerto Rican public debt was 70% as large as GNP. (Now it is slightly more than 100%.) Under this debt pressure, in an effort to cut its expenditures, the government temporarily laid off without pay 100,000 workers (almost 10% of the total work force). Had the Puerto Rican economy not been so weak and had the U.S. economy not soon entered the Great Recession, perhaps the downturn from this layoff shock would have been brief. But the weak economy and then recession in the states undercut any basis for quick recovery. In 2009 and 2010, Puerto Rico did receive a share of the funds in the American Recovery and Reinvestment Act (ARRA), which attenuated but did not end the island’s recession. The boost from the ARRA funds was too small and too short-lived.

Many commentators and Puerto Rican government officials try to explain the emergence of Puerto Rico’s recession by the termination of the Section 936 tax breaks and call for a renewal of 936 provisions to aid the economy. However, for the firms, the tax breaks did not end, but were maintained under other tax code provisions, and there was virtually no decline of employment in 936 firms as the tax provision was being phased out between 1996 and 2006. After 2006, however, the employment provisions of Section 936, as weak as they were, did collapse. As a result, while exports of pharmaceuticals have grown apace in subsequent year, for example, employment in the industry has dropped sharply. Perhaps the termination of 936 contributed to the continuation of the downturn, through its impact on employment, but it was not the primary or major causal factor. Most important, a renewal of 936 provisions is not a solution to Puerto Rico’s economic difficulties.

Controversy over Puerto Rico’s status has been a dominating theme of the island’s politics for decades. Various polls have shown a rough split between maintaining the current status and statehood, with the latter gaining an edge in the 2012 poll associated with the election. The polls show support for independence far behind.

The current colonial status, in addition to its negative economic impact, involves a fundamental violation of human rights and democracy. Puerto Ricans should be given a clear choice between independence and statehood; maintenance of the current colonial status (or a somewhat different colonial status that has some support) should be off the table. Beyond the interests of the Puerto Ricans, how can those of us in the states make a claim to democracy while we hold Puerto Rico as our colony?

is professor emeritus of economics at UMass-Boston and a Dollars & Sense Associate.

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