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SECTION 936 TAX CREDITS WOULD BE PHASED OUT BY 1996 IF PUERTO RICO GAINS STATEHOOD OR INDEPENDENCE, UNDER BILL PASSED BY SENATE FINANCE COMMITTEE

Executive Summary

"Section 936" tax credits would be phased out by 1996 if Puerto Rico becomes either a U.S. state or an independent nation, under an amendment the Senate Finance Committee tied to legislation (S 712) that would provide Puerto Ricans with a referendum on self-determination. Both the committee amendment and overall bill were approved by unanimous committee voice vote Aug. 1. The bill calls for a summer 1991 referendum by Puerto Rican citizens. Under the amendment, if either statehood or independence is chosen, the amount of Sec. 936 tax credit available for Puerto Rico operations would be phased out beginning with the second year after the referendum is certified. The credit would be reduced by 25% in that second year, 50% in the third year, and 75% in the fourth year, and then eliminated entirely. Thus, the credits would end by 1996, assuming the referendum takes place in 1991 as planned. The bill previously had specified that statehood would entail a phase-out of the credits by 1997, while independence would result in their immediate deletion ("The Pink Sheet" Dec. 4, T&G-6). One goal of the Finance Committee is to make the economic impact of the three options roughly equivalent so that the voters' decision is a political, not economic, one. The committee also designed the bill's tax changes in part with an eye to making the overall package of amendments "budget neutral." The bill specifies that statehood, if selected, would take effect in 1996 at the same time that the Section 936 credits and certain other policies are phased out. This would avoid constitutional questions that would arise if unique federal tax benefits were available to one state. The committee rejected Sen. Moynihan's (D-N.Y.) proposal that would make 1993 the effective year of statehood if the Supreme Court provided an expedited review of the constitutional issues. The referendum is self-executing; that is, Congress need not take further action to implement the decision of Puerto Rico voters. The proposed Section 936 transition would increase federal revenues by $453 mil. in 1993, $1.2 bil. in 1994 and $1.9 bil. in 1995. Even if Puerto Ricans vote to remain a commonwealth, however, the tax credit would be trimmed. In order to obtain the credit at present, a domestic corporation must derive at least 75% of its gross income from the active conduct of a trade or business within a U.S. possession over a three-year period. This threshold would be raised to 80% in the fourth taxable year after certification of the referendum and to 85% for subsequent years. Increased federal revenues of $30 mil. are estimated for 1995 under the provision. Committee member Pryor (D-Ark.) is drafting an amendment to reorient the Section 936 credit to the amount of wages paid by firms. He asserted that, because the credit currently is geared to profit levels, it favors large profitable companies with fewer employees over smaller companies with many employees. Pryor's staff will work on the proposal over the August congressional recess. The senator's options include offering the amendment during markup by the Agriculture Committee, of which he is a member, or on the Senate floor. Pryor said that pharmaceutical companies receive a tax benefit of $58,000 per Puerto Rican employee, contrasted with per-employee benefits of $20,600 for the machinery industry and$3,200 per employee for apparel manufacturers. Those figures are drawn from a report issued early last year by the Treasury Department. Treasury has also estimated that pharmaceutical firms receive $265 in tax credits for every $100 they spend on wages in Puerto Rico ("The Pink Sheet" April 16, T&G-7). Under Pryor's plan, the tax credit would be equal to 80% of an employee's wages, up to the federal minimum wage, and then 30% of wages above that level. The total credit per employee would be capped at four times the federal minimum wage. Pryor's interest in tax policies affecting the drug industry is not new: for example, he questioned the Puerto Rico credit during July 1989 hearings on pharmaceutical prices. A wage-based approach also had been floated by the Reagan Administration during tax reform talks in the 1980s.
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