Tax Policy

This report provides information on economic activity in Puerto Rico before and after the recent changes in U.S. tax benefits for corporations operating there. Corporations that receive these tax benefits are a significant part of the Puerto Rican economy. In recent years, Congress has reduced the size of the tax benefits and set an expiration date for the remaining benefits. GAO presents information on recent trends in Puerto Rico's principal economic indicators; investments by U.S. corporations in Puerto Rico that generate tax-exempt, nonbusiness income; and investment and employment promoted by Puerto Rico's Economic Development Administration.

GAO noted that: (1) the recent trends in Puerto Rican economic indicators show an economy that is growing in income, employment, and investment in most years; (2) although the growth in these indicators continued after the 1993 changes to the section 936 tax credit, GAO cannot conclude that the changes have had no effect on the Puerto Rican economy; (3) income as measured by Puerto Rico's gross domestic product and gross national product both increased between 1982 and 1996, with the increases continuing at about the same rates after the 1993 changes in the credit; (4) although the share of domestic net income of Puerto Rican residents declined from 69.3 to 59.8 percent between 1982 and 1996, their net income grew in absolute terms from $16.3 billion to $23.8 billion; (5) unemployment declined in most years between 1982 and 1996 and also declined or remained unchanged in every year after the 1993 changes to the credit; (6) investment spending for the plant and equipment that increases the economy's ability to generate income also increased in most years during this period; (7) although investment increased, and unemployment did not increase, after the changes to the credit, GAO does not know if the rate of change of either of these indicators would have been greater if the credit had not been changed; (8) during the last 2 calendar quarters of 1996, when the tax benefits for QPSII were ending, the total value of investments in Puerto Rico that formerly would have generated QPSII benefits grew from about $15.6 billion to $16.4 billion and then fell to about $14.6 billion; (9) a recent amendment to a Puerto Rican financial regulation may have influenced the financial investment behavior of possessions corporations during that period even more than the repeal of the exemption for QPSII; (10) it is possible that the funds that possessions corporations reinvest in Puerto Rico's financial system simply displace other funds that would have been available to Puerto Rican businesses, rather than expand the pool of available funds; (11) the amount of foreign investment dollars committed to projects promoted by the Economic Development Administration (EDA) were at their highest levels in the late 1980s and early 1990s and have generally declined thereafter; and (12) this trend continued immediately after the 1993 changes in the section 936 tax credit, when in 1994 investment by overseas businesses in EDA promotions was at its lowest level for any year between 1982 and 1996.