How Washington and Wall Street Broke Puerto Rico

The island is a colony by another name, denied basic rights afforded to states and preyed upon by bankers. Hurricane Maria was a 100-year disaster in the making

By Gil Hall and cross-posted from The Daily Beast

President Donald Trump aggravated an already tense situation Thursday by blaming Puerto Rico for the chaos it faces after Hurricane Maria. While it’s clear that Puerto Rico’s failure to perform routine maintenance did indeed leave the island particularly vulnerable, in quoting journalist Sharyl Attkisson’s comment that “Puerto Rico survived the Hurricanes, now a financial crisis looms largely of their own making,” Trump ignores the significant role the federal government’s colonial policies, oversight failures, and funding mechanisms have contributed to the instability.

After the United States took Puerto Rico, Guam, and the Philippines from Spain in 1898, Congress looked for ways to pay operating expenses for the new colonies that minimized direct federal funding and that expressly allowed treatment unequal to that of states. A key component of this plan for Puerto Rico, signed into law in 1917, included creating a separate tax system outside the jurisdiction of the Internal Revenue Service. Residents pay no federal income tax and most corporations are exempt from many federal taxes. That allowed Puerto Rico to issue “triple tax-exempt” bonds, which are exempt from local, state, and federal taxes. By contrast bonds issued by states and municipalities are exempt at the federal level but not necessarily at the state and local levels.

After the Great Depression, mainland businesses, mostly small manufacturers, came to Puerto Rico, attracted by its large labor pool, low labor costs (Puerto Rico’s minimum wage was not equalized to the mainland until 1983), and duty-free access to the U.S. markets. By the early 1970s Puerto Rico’s economic progress had stagnated and  highlighted Puerto Rico’s inability to compete long-term with mainland states or to substantially grow its output or trade.

However, rather than working to alter the core issues of the economy that would have long-lasting effects, Puerto Rico instead turned to tax gimmicks. With Congress’ help, IRS section 936 was created in 1976 that allowed Puerto Rico’s companies the ability to transfer their income to their U.S. parent companies, tax-free. Mainland companies, particularly pharmaceuticals, flocked to Puerto Rico to take advantage of the scheme.

The program did not have the effect Puerto Rico had promised Congress it would, however. The federal treasury lost out on billions of dollars of tax revenues each year, yet Puerto Rico gained relatively few jobs.

Congress nonetheless played along. Always eager to avoid conversation on the tense topic of Puerto Rico—the United States has never extended the full Constitution to the island—Congress tweaked the law several times, but substantially left rule 936 in place until President Bill Clinton sought to balance the federal budget and phased it out beginning in  1996.

Soon after, Puerto Rico began to truly capitalize on its other unique power: to create bonds that were triple-tax-exempt.

The tax benefits these bonds provided to high-income individuals in high-tax mainland jurisdictions were unrivalled. The market’s insatiable appetite for investment vehicles with significant tax advantages created the perfect environment for uncontrolled borrowing.

Decade after decade, Puerto Rico hit borrowing limits and needed a workaround. Each time, instead of looking to change the fundamentals of the economy with the aim of stable but slow growth, Puerto Rico opted for easy money, which Wall Street was happy to provide

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