Our little-know rum tax policy is corporate welfare at its finest

Lawmakers subsidize things they want. These include manufacturing and investing. 

They also tax things they don’t want. Hence the “sin taxes” on cigarettes and alcohol. 

So overall tax policy is aimed at encouraging people to smoke and drink less. Right? 

Not always. At least one sin tax on the books is encouraging the production of alcohol while pitting two American territories against each other in a contest that neither can win. Oh, and it is making foreign companies rich with corporate welfare. 

You’ve probably never thought much about this, but “when you buy a bottle of rum in the United States, by law nearly all the federal taxes on that rum must be sent to Puerto Rico and the U.S. Virgin Islands,” NPR reports. 

“It’s an unusual system that Congress designed decades ago to help fund these two U.S. territories. In 2021 alone, these rum tax payments added up to more than $700 million.” 

Washington inside-the-Beltway types call this a “cover-over” program, but that term just translates to “sent back to,” meaning the taxes collected on the mainland are sent back to the Caribbean governments. That may seem harmless; of course, these islands should benefit from their rum production. 

However, the program merely encourages the territories to compete against each other, and the real beneficiaries are the few companies that make the rum. It is simply corporate welfare in action. 

“The design of the cover-over program has forced Puerto Rico and the U.S. Virgin Islands into a lose-lose competition in which they manipulate their rum industries to maximize federal subsidies — most of which are plowed back into the subsidy wars,” explains Adam Michel for the CATO Institute.  

That wasn’t always the case. Until about 15 years ago, almost all the funding was used to support economic development. But then the U.S. Virgin Islands ponied up some $2.7 billion to bribe Diageo, maker of Captain Morgan rum, into moving from Puerto Rico to St. Croix, even though the move only created a few dozen jobs. 

In response, Puerto Rico changed the way it managed the money coming back from Washington. Since that time, much of the cover-over money has instead gone to rum manufacturers as corporate welfare. 

The Center for Investigative Journalism reported that almost half a billion dollars were diverted directly to just three companies, including Bacardí, the world’s largest rum producer. Meanwhile, that industry now pays 18 percent less in taxes than it did before the policy change. 

Taxpayers in the Caribbean aren’t the only victims of this corporate welfare. 

“U.S. mainland rum distillers also lose as their large incumbent rivals receive lavish funding for production in the territories,” Michel notes. 

Meanwhile, the policy also encourages overproduction. 

“By producing more rum, each territory has the ability to increase their share of the rum tax,” Michel wrote for the Tax Foundation. 

However, overproduction can only drive down the value of rum. During World War II, the famed drink the “Hurricane” was invented in New Orleans because Pat O’Brien’s bar had too much rum and wanted to find a way to use it up. There is still plenty today. 

The government should not be subsidizing the production of alcohol. If it keeps doing so, it may soon be supporting more than rum. 

“The tax incentives are so generous that Virgin Island producers might ultimately try to use highly subsidized sugar cane to make blended whiskeys, vodka and gin,” the New York Times reports. That should worry senators from whiskey-making and corn-growing states.  

This program was set up to help the people of the islands. Instead, “the unintended consequences of the cover-over program have led both Puerto Rico and the U.S. Virgin Islands to manipulate their economies to maximize federal subsidies,” according to Michel. “The ensuing subsidies race distorts the economy, creates perverse incentives, and destabilizes local government.” 

Next year, regardless of whether Kamala Harris, Donald Trump or somebody else is elected president, lawmakers will need to update the 2017 tax bill. Before they vote on that larger matter, lawmakers ought to mix themselves a Hurricane, and then agree to fix rum policy.  

Eliminating this kickback would crack down on wasteful corporate welfare, help citizens in the Caribbean and improve tax policy nationwide. 

Rich Tucker is a writer and editor based in Richmond, Virginia. His work can be found at https://richardbriantucker.substack.com/.