Congress can’t dodge Puerto Rico’s status in tax debate

The devil is in the details, more so in the tax code. We would do well to remember that all tax reform is fundamentally a policy decision on how to justify wealth distribution through the conveyor belt of government and the burdening of certain sectors of the economy with the cost for underwriting its operation.

As to be expected, in the ongoing debate regarding tax reform lawmakers are generally arguing from their respective political positions: Republicans favoring tax cuts for the benefit of taxpayers and Democrats favoring continued funding of federal programs at the expense of wealthier taxpayer.

{mosads}Of course, this general statement loses its sharpness as soon as we focus in the details of the proposed statutory language and the different interest groups that either benefit or are harmed by it.

A close reading of certain provisions of the tax reform bill as approved by the House Ways and Means Committee, for example, reflect the ongoing debate in the Republican Party regarding how to treat Controlled Foreign Corporations and whether their earnings should be subject to a 20 percent taxation rate at the time of entering the United States.

Clearly, in this case the protectionist policy — “America first” — promoted by the Trump administration and the traditional protection of capital by the Republican Party are at loggerheads. Independently of the merits or demerits of the proposal, or of their fiscal and economic desirability, this particular provision has a significant impact on Puerto Rico and again brings to the fore its outstanding political status question.

Under the current tax code, Controlled Foreign Corporations in Puerto Rico are deemed to be “foreign“ for purposes of being exempt of federal taxation.

According to the General Accounting Office (GAO) 2014 report on the cost of statehood, in 2011 the foreign corporations in Puerto Rico did not report $30 billion in earnings. Not all these earnings are produced in Puerto Rico, although they are reported as from there through perfectly legal accounting practices.

According to Puerto Rico government officials and spokespersons for the manufacturing sector, 30 percent of the Gross Domestic Product is dependent on these “foreign” corporations, and a third of the revenues of the island government are derived from the 4 percent toll gate tax that they pay, in an arrangement with the Internal Revenue Services that gives these same corporations a tax credit when reported in the United States.

As currently phrased, the proposed tax reform would classify the Controlled Foreign Corporations in Puerto Rico as “foreign” for purposes of uniformly imposing a 20 percent taxation rate on their earnings, just as they would apply to any other American subsidiary corporation in any other foreign country.

This proposal has met the opposition of Puerto Rico Gov. Ricardo Rosselló who argues that such an amendment to the tax law would lessen Puerto Rico’s competitiveness at a time of fiscal crisis and hurricane devastation. Instead, the government favors that Controlled Foreign Corporations be classified as domestic corporations under the proposed tax reform bill.

Resident Commissioner Jenniffer González Colón favors creating a tax exemption for Controlled Foreign Corporations based on job creation, similar to the previous tax code section 30-A.

Both suggestion are not incompatible.

Underlining this discussion, there appears to be disregard by Congress of how the current political status is the cause and effect of these proposals. The non-incorporated nature of the Territory of Puerto Rico permits Congress to legislate under the plenary powers of Article IV, Section 3 of the Constitution.

The non-incorporated territory is a doctrine created by the insular cases at the turn of the 20th Century for purposes of not extending full constitutional rights to Puerto Rico. We need to recall that the early insular 1901 cases Downes v. Bidwell and De Lima v. Bidwell were about the validity of tariff barriers imposed on Puerto Rico imports contrary to Uniformity Clause, Article I, Section 8 of the Constitution, which requires that “all Duties, Imposts and Excises shall be uniform throughout the United States”.

With the advent of the doctrine of non-incorporation Congress has had the constitutional blessing from the Supreme Court throughout the last 116 years to discriminate against Puerto Rico in favor of those other economic interest it has decided to favor. This is notwithstanding the fact that Puerto Ricans are American citizens since 1917.

For example, in the past, section 936 of the tax code benefited American based manufacturing corporations with exemptions that they could not otherwise have in the 50 states, and which was repealed in 1996 by the Clinton administration as “corporate welfare.”

Also, the Puerto Rico bonds enjoyed competitive advantage in the municipal bonds market for many decades for its triple tax exemption, including federal taxation. Such an exemption was (and is) only possible under the doctrine of non-incorporated territory.

It is fair to state that the current fiscal and economic woes of Puerto Rico are due in great measure to the doctrine of non-incorporated territory which has until recently benefited the short-term financial goals of investors, manufacturers and certain political sectors in Puerto Rico — at the expense of long-term stability and growth and the political and constitutional rights of the American citizens of Puerto Rico.    

Any amendment to the tax code affecting Puerto Rico needs to include a review of the non-incorporation doctrine. We invite Congress to revisit previous legislation regarding incorporation of the territory of Puerto Rico, and any change in its tax policy be coupled with a long-term commitment to its eventual admission as a state.

Andrés L. Córdova is a law professor at Inter American University of Puerto Rico, where he teaches contracts and property courses. He is also an occasional columnist on legal and political issues at the Spanish daily El Vocero de Puerto Rico.