United States General Accounting Office

GAO Report to the Chairman, Committee on

Finance, U.S. Senate

May 1997 TAX POLICY

Puerto Rican

Economic Trends

GAO/GGD-97-101

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-276674 

May 14, 1997

The Honorable William V. Roth, Jr.

Chairman, Committee on Finance

United States Senate

Dear Mr. Chairman:

In response to your request, this report provides information on economic

activity in Puerto Rico, before and after the recent changes in U.S. tax

benefits1

 for corporations operating there. Corporations that receive these

tax benefits represent a significant sector 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. The last benefits are authorized

to be available for tax years beginning before January 1, 2006, although the

administration’s fiscal year 1998 budget proposes to extend the availability

of some of the tax benefits indefinitely.

In light of these tax law changes, you asked us to present information on

the 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.

Background

The Section 936 Tax Credit Income derived from operations of U.S. corporations in U.S. possessions

has been subject to special tax provisions since the Revenue Act of 1921.

These provisions were primarily intended to help U.S. corporations

compete with foreign firms in the Philippines (then a U.S. possession).

With the Tax Reform Act of 1976, Congress connected the special tax

provisions with the development of possessions’ economies. The 1976 Act

created section 936 of the IRC, which revised the treatment of corporate

income from U.S. possessions. The stated purpose of the tax credit

established under that section was to “assist the U.S. possessions in

obtaining employment producing investments by U.S. corporations.”

1

Under section 936 of the Internal Revenue Code (IRC).

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Prior to 1994, the section 936 tax credit was equal to the full amount of the

U.S. income tax liability on income from a possession. The credit

effectively exempted two kinds of income from U.S. taxation:

• income from the active conduct of a trade or business in a possession, or

from the sale or exchange of substantially all of the assets used by the

corporation in the active conduct of such trade or business and

• certain income earned from financial investments in U.S. possessions or

certain foreign countries, generally referred to as qualified possession

source investment income (QPSII).

In order for the income from an investment to qualify as QPSII, the funds for

the investment must have been generated from an active business in a

possession, and they must be reinvested in the same possession. Dividends

repatriated from a U.S. subsidiary to a mainland parent have qualified for a

dividend-received deduction since 1976, thus allowing tax-free repatriation

of possessions income.

The 1993 Budget Act2

 placed caps on the amounts of section 936 credit

that corporations could earn for tax years beginning in 1994 or later. The

Small Business Job Protection Act of 1996 repealed the tax credit for

taxable years beginning after 1995.3

 However, the act provides transition

rules under which a corporation that was an existing credit claimant is

eligible to claim credits with respect to possession business income for a

period lasting through taxable years beginning before 2006. For tax years

beginning after December 31, 1995, QPSII received or accrued after June 30,

1996 may not be used in figuring the credit.

Puerto Rican Investment

Incentives

Over the years, the government of Puerto Rico has taken several steps to

encourage corporations to invest in the island and to retain their earnings

there. Under Puerto Rico’s current industrial incentives law, corporations

engaged in manufacturing or export services generally are allowed

90-percent exemptions on their industrial development income.4

 These

exemptions are valid for 10 to 25 years, depending on the location of the

business’ operations. The Puerto Rican government encourages the

2

Omnibus Budget Reconciliation Act of 1993, P. L. No. 103-66, S 13227, 107 Stat. 312, 489 (1993).

Appendix I provides additional details on the changes made to the credit by this and other acts signed

into law since 1982.

3

Small Business Job Protection Act, P.L. No. 104-188, S 1601, 110 Stat. 1755, 1827 (1996).

4

The current Tax Incentives Act became effective in 1987 and is due to expire at the end of 1997. The

government is currently drafting new incentive legislation.

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partially exempt corporations to reinvest their business profits in the

island by including in the definition of industrial development income all

income derived from specified financial assets. This financial income

exempted under Puerto Rican law was also treated as QPSII under federal

tax law if it was earned by a possessions corporation.5

The “tollgate tax,” which Puerto Rico imposes on dividends that resident

corporations pay to nonresident shareholders, provides an additional

incentive for eligible corporations to reinvest their earnings in Puerto

Rico. The rate of this tax on dividends paid out of the income of a tax

exempt business is generally 10 percent. However, the rate is reduced if a

corporation reinvests a certain portion of its earnings in Puerto Rico for a

period of 5 or more years.

The Economic Development Administration (EDA)/Industrial Development

Company (PRIDCO) of Puerto Rico promotes investments on the island by

both local and overseas businesses. Generally, but not always, the

investments promoted by EDA receive tax exemptions under Puerto Rican

tax incentive legislation. EDA compiles data on the number of “promotion

projects” initiated each month as a result of its activities. It also compiles

data on the amount of investment and employment that businesses

commit to when initiating a project.

Results in Brief The recent trends in Puerto Rican economic indicators show an economy

that is growing in income, employment, and investment in most years.

Income and employment are traditional indicators of current economic

performance, while investment is an indicator of the economy’s capacity

to increase income and employment in the future. Although the growth in

these indicators continued after the 1993 changes to the section 936 tax

credit, we cannot conclude that the changes have had no effect on the

Puerto Rican economy. The Puerto Rican economy is strongly influenced

by the U.S. economy. If the changes in the credit have had any negative

impact on Puerto Rico’s economy to date, this may have been offset by the

positive influence of the U.S. economic recovery after 1991. Recent

economic initiatives by the Government of Puerto Rico also may have

offset any such impacts. Furthermore, the effect of the credit changes may

require several years to have an impact on the Puerto Rican economy

5

A “possession corporation” is one that elects to be taxed under section 936 of the IRC and meets the

following two requirements: over a 3-year period preceding a taxable year, 80 percent or more of its

income must be derived from sources within a possession; and 75 percent or more of its income must

be derived from the active conduct of trade or business within a possession. To qualify for both U.S.

and Puerto Rican tax benefits, the corporation would have had to make the investment in the specified

assets with earnings derived from its active business in Puerto Rico.

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because (1) it may take time for companies to adjust their investment

plans and (2) each year’s investment by companies represents a relatively

small proportion of the commonwealth’s total capital stock, which

generates employment and income.

Income as measured by Puerto Rico’s gross domestic product (GDP) and

gross national product (GNP) both increased between 1982 and 1996, with

the increases continuing at about the same rates after the 1993 changes in

the credit. GDP, a measure of the total income produced in Puerto Rico,

grew at a faster rate than GNP, which measures the portion of total income

received by Puerto Rican residents. The faster rate of growth of GDP

compared with GNP means that an increasing portion of the income

produced in Puerto Rico went to U.S. and foreign investors. These trends

are consistent with a development strategy based on attracting external

investment. 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.6

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. Investment spending for the plant and equipment that increases

the economy’s ability to generate income also increased in most years

during this period. After leveling off for several years after 1989, possibly

due to the U.S. recession, investment increased again in 1995 and 1996.

The section 936 tax credit was intended to promote investment and

employment in Puerto Rico. Although investment increased, and

unemployment did not increase, after the changes to the credit, we do not

know if the rate of change of either of these indicators would have been

greater if the credit had not been changed.

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. 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. Consequently, that

investment behavior may be a poor indicator of the corporations’

longer-term reaction to the repeal.

6

Unless otherwise noted, all of the dollar values presented in this report have been restated in constant

1996 dollars. Similarly, all growth rates have been computed as changes in constant-dollar figures.

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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. A simple comparison of trends shows that total

investment in buildings, machinery, and equipment has grown in all but 1

year since 1987, despite the fact that the amount of exempt investment

funds held in Puerto Rican financial institutions declined in all but 2 years

during that period.

The amount of foreign investment dollars committed to projects promoted

by EDA were at their highest levels in the late 1980s and early 1990s and

have generally declined thereafter. 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. However, this investment increased moderately in

1995 and 1996.

Objectives, Scope,

and Methodology

To present the trends in Puerto Rican economic indicators, we obtained

the latest economic data available from the Puerto Rican Planning Board.

To present the trends in qualified possessions source investments, we

obtained the latest data available from Puerto Rico’s Commissioner of

Financial Institutions concerning exempt business investments in financial

assets in Puerto Rico. To present the trends in investment and

employment promoted by Puerto Rico’s EDA, we obtained the most recent

data compiled on those items by EDA. We also interviewed officials from

the aforementioned agencies as well as from the Government

Development Bank of Puerto Rico and the Puerto Rican Department of the

Treasury on issues relating to data and to Puerto Rican tax laws and

industrial incentives laws.

We restated all dollar figures in constant 1996 dollars, using the most

appropriate price indexes available. In most cases we used the implicit

price deflator for Puerto Rico’s GNP.

7

 We did not independently verify the

accuracy of the data we obtained for this report.

7

The implicit price deflator for Puerto Rico’s GNP is available only for the end of each fiscal year.

Puerto Rico’s fiscal year ends June 30th. In order to avoid distorting end-of-year adjustments in the

report graphs that display quarterly data, we estimated quarterly deflators by assuming that the annual

growth in the deflator would occur at a constant rate throughout the year. Also, in order to present

consistent trend lines in the cases where our quarterly data extends to December 1996, we projected

the deflator to grow for the last two calendar quarters of 1996 at the same pace it did between fiscal

year 1995 and fiscal year 1996. Figures for 1996 that we cite in the text have not been adjusted and,

therefore, are slightly higher than the adjusted figures represented in the graphs.

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We also reviewed publications of the U.S. Treasury Department and the

Internal Revenue Service and some of our prior reports relating to

activities of possessions corporations and the effectiveness of the section

936 tax credit. We did not attempt to estimate the effects of the recent

changes in the section 936 tax credit on the Puerto Rican economy. We

have simply described changes in that economy in recent years.

We did our work in Washington, D.C., in March and April 1997 in

accordance with generally accepted government auditing standards. We

requested comments on a draft of this report from the Secretary of the

Treasury of the Commonwealth of Puerto Rico, Puerto Rico’s

Commissioner of Financial Institutions, the heads of Puerto Rico’s

Planning Board, and Economic Development Administration, and from the

Secretary of the Treasury. These comments are summarized and discussed

at the end of this report and are reprinted in appendices IV through VII.

Puerto Rico’s

Economy

As shown by its GNP and GDP, Puerto Rico’s economy has been growing in

most years, and this trend continued in the 3 years immediately following

the 1993 changes to the section 936 tax credit. (See fig. 1.) Between 1982

and 1996, Puerto Rico’s per capita GNP grew at an annual rate of

1.7 percent, and its GDP grew at an annual rate of 3.5 percent. The growth

of both indicators slowed somewhat after 1990 following the recession

that occurred in the U.S., but per capita GDP began to grow more quickly in

1992 as did per capita GNP in 1993.

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Figure 1: Gross Domestic and Gross

National Product Per Capita, 1982-1996

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Dollars (constant 1996)

GDP per capita

GNP per capita

Year

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Note: Figures were adjusted for inflation using the Puerto Rican GDP and GNP deflators.

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years.

The faster rate of growth for Puerto Rico’s GDP compared with GNP means

that an increasing portion of total income produced in Puerto Rico went to

U.S. and foreign investors rather than to Puerto Rican residents. GDP is a

measure of total income produced in Puerto Rico, and GNP is a measure of

the income produced that is received by the residents of Puerto Rico. The

difference between the two represents, for the most part, remittance of

profit and interest income to U.S. and foreign investors. The trends in GDP

and GNP are consistent with Puerto Rico’s development strategy, which

emphasizes long-term tax reductions to firms that locate in Puerto Rico,

Page 7 GAO/GGD-97-101 Puerto Rican Economic Trends
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and with the provisions of the U.S. IRC—such as the section 936 tax credit,

which allowed tax-free repatriation of profits to the mainland. Although

the share of residents of Puerto Rico in total net income from property and

employee compensation declined from 69.3 to 59.8 percent between 1982

and 1996, residents’ income grew in absolute terms from $16.3 billion to

$23.8 billion. (For more details on resident and nonresident income in

Puerto Rico, see app. II.)

Investment in Puerto Rico, which is a key factor in the growth in the

Puerto Rican economy, has begun to grow again after leveling off in the

early 1990s. (See fig. 2.) Gross domestic fixed investment is the amount of

resources used to replace capital consumed during the year and to add to

the capital stock. This investment includes both public and private

spending on the construction of housing and production facilities, and

spending on machinery and equipment. Gross private fixed investment

grew significantly between 1982 and 1989 and then leveled off for several

years, possibly due to the recession that occurred in the United States.

Growth in investment picked up again in 1995 and 1996. (See app. II for

more details on investment.)

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Figure 2: Public and Private Gross Fixed Investment, 1982-1996

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

2

4

6

8

Dollars in billions (constant 1996)

Fiscal year

Gross private fixed investment 

Gross public fixed investment 

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflators for investment.

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years.

The section 936 tax credit was intended to promote investment and

income growth in Puerto Rico, and the limitations on the credit may

reduce the attractiveness of U.S. investment in Puerto Rico. Although

investment and income have grown after the limitations became effective,

we cannot conclude that the credit changes have not had any effect on

investment or income. The rates of growth may have been greater without

the credit changes. Moreover, it may require more years for the credit

changes to affect investment and income because (1) it may take time for

Page 9 GAO/GGD-97-101 Puerto Rican Economic Trends
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companies to adjust their investment plans and (2) each year’s investment

by companies represents a relatively small proportion of the

commonwealth’s total capital stock, which generates employment and

income.

From 1982 to 1996, unemployment in Puerto Rico generally declined,

while the participation of Puerto Rican residents in the labor force

increased. (See fig. 3.) The unemployment rate in Puerto Rico was

23.5 percent in 1983, following the recession that the United States entered

in 1981 and 1982, but declined in most years after 1983 to reach a low of

13.8 percent in 1995 and 1996. The labor force participation rate increased

during this period from an average rate of 43 percent during the 1980s to

an average of 46 percent during the 1990s. The trend in employment

continued after the changes to the section 936 tax credit with the

unemployment rate falling or remaining unchanged in every year after

1993.

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Figure 3: Labor Participation and

Unemployment Rates, 1982-1996

0

10

20

30

40

50

Rate of participation/unemployment (percent)

Participation rates

Unemployment rates

Fiscal year

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years.

Total nonagricultural employment in establishments in Puerto Rico grew

from 660,000 in 1982 to 945,000 in 1996. Over this period, the share of

manufacturing employment declined from 22.4 percent of the total to

16.3 percent, and the share of government employment fell from

36.2 percent to 32.6 percent. Manufacturing employment has actually

fallen in absolute terms since it peaked in 1990. In contrast, the share of

employment in the retail trade sector rose from 12 percent to 15.8 percent,

and the share of the nonfinancial service sector rose from 13.3 percent to

18.5 percent. (For more details on employment in Puerto Rico, see app. II.)

Page 11 GAO/GGD-97-101 Puerto Rican Economic Trends
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Recent Trends in

Qualified Possessions

Source Investments

Prior to 1996, possessions corporations with active trades or businesses in

Puerto Rico could reinvest the earnings from those activities in eligible

financial investments in Puerto Rico and earn income that was effectively

exempt from both U.S. and Puerto Rican income taxes.8

 For tax years

beginning after December 31, 1995, QPSII received or accrued after June 30,

1996, does not qualify for a federal tax credit.9

 However, the Puerto Rican

income tax exemption and tollgate tax both remain in place and provide

some disincentive to an immediate repatriation of all financial assets held

by possessions corporations.

As of December 1996, total investment in the exempt financial assets

amounted to $14.6 billion, or $3,927 per resident of Puerto Rico. This

$14.6 billion figure is the best available accounting of the current value of

investments that formerly would have generated tax benefits under the

QPSII credit. Almost all investments that would have generated QPSII tax

benefits are included in that amount,10 and only about 1 percent of that

amount is attributable to businesses that would not have qualified for QPSII

benefits.11 Exempt businesses can make eligible financial investments

either directly or through the intermediation of eligible financial

institutions. Businesses invested $10.5 billion of the $14.6 billion through

financial institutions and invested the remaining $4.1 billion directly.

8

A possessions corporation must also have been granted an exemption under Puerto Rico’s industrial

incentives law to receive this double benefit. Historically, almost all possessions corporations have

been granted at least partial exemptions from Puerto Rican income tax. According to IRS, for tax year

1993 there were about 455 active possessions corporations in Puerto Rico. Data from the Puerto Rican

Department of Treasury show that 439 possessions corporations received at least partial exemptions

in fiscal year 1993.

9

According to Puerto Rico’s Commissioner of Financial Institutions, most of the tax-year ends for

possessions corporations with large investments in Puerto Rican financial institutions are October 31

and November 30. For those corporations, the QPSII benefits ended as of October 31 and

November 30, 1996.

10Possessions corporations operating in Puerto Rico did not receive much, if any, tax benefit from

section 936 unless their income from Puerto Rico was also exempt from the commonwealth’s income

tax. In the absence of section 936, the corporations would have received foreign tax credits for income

taxes paid to Puerto Rico. These foreign tax credits would have provided roughly the same benefit as

the section 936 credit. Consequently, only financial investments that produced Puerto Rican exempt

income would generate tax benefits under the QPSII credit. The $14.6 billion figure is the Government

of Puerto Rico’s best accounting of all financial investments in Puerto Rico that produce tax exempt

income.

11Locally owned Puerto Rican businesses that have been granted industrial incentive exemptions may

also reinvest their earnings in the eligible financial assets. However, an official from Puerto Rico’s

Department of Treasury told us that possessions corporations earned 99 percent of all income from

eligible financial assets.

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Figure 4 presents aggregate data available on exempt financial

investments in recent years.12 Total exempt financial investment grew

noticeably during the second and third calendar quarters of 1996, reaching

$16.4 billion at the end of September 1996. Most of this increase was offset

by a decline during the fourth quarter of 1996. During those 3 quarters,

exempt investments in eligible financial institutions grew more rapidly and

then declined less sharply than direct exempt financial investments.

Moreover, as the data in figure 5 indicate, there was a pronounced shifting

of funds out of instruments with maturities of 1 year or less and into

instruments with longer maturities.

12Although the government of Puerto Rico has compiled data on the amount of eligible investments in

financial institutions for many years, it has been able to collect data on the amount of eligible

investments that corporations make directly only since June of 1995.

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Figure 4: Exempt Financial

Investments, 1992-1996

0

5

10

15

20

Dollars in billions (constant 1996)

1992 1994 1995 1996

Jun

Sept

Dec

1993

Mar

Jun

Sept

Dec

Mar

Jun

Sept

Dec

Mar

Jun

Sept

Dec

Mar

Jun

Sept

Dec

Calendar year quarters

Exempt investment in eligible financial institutions

Total exempt financial investment

Direct exempt financial investment

Note: Data points represent end of quarter balances. Figures were adjusted for inflation using the

Puerto Rican GNP deflator. Data on direct and total investment were available only since

June 1995.

Source: Government of Puerto Rico, Commissioner of Financial Institutions.

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Figure 5: Exempt Investments in Eligible Financial Institutions, by Maturity, 1992-1996

Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec

0

2

4

6

8

10

12

Calendar year quarters

Dollars in billions (constant 1996) 

1 year or less

over 1 year

1992 1993 1994 1995 1996

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflator.

Source: Government of Puerto Rico, Commissioner of Financial Institutions.

According to Puerto Rico’s Commissioner of Financial Institutions, much

of the short-term growth in investments with longer maturities may be a

response to a recent amendment to the commonwealth’s regulation that

governs tax exempt funds held in eligible financial institutions. The

amendment had the affect of reducing the rate of interest that financial

institutions could pay on exempt funds placed in instruments with

maturities of 5 years or more. Possessions corporations that planned on

reinvesting earnings in Puerto Rico to obtain a lower tollgate tax rate are

Page 15 GAO/GGD-97-101 Puerto Rican Economic Trends
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likely to have accelerated their investments in long-term instruments in

order to lock in more favorable rates before the effective date of the

amendment.13

Due to the influence of the amendment to Puerto Rico’s financial

regulation, the investment behavior of possessions corporations during the

first 6 months after the repeal of QPSII may be a poor indicator of their

longer-term reaction to the repeal. Nevertheless, the sharp increase in

long-term investments held in eligible financial institutions indicates that

those funds, at least, are not likely to be repatriated in the immediate

future.

No Clear Relationship

Between Trend in Exempt

Investments in Financial

Institutions and Trend in

Total Investment

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. A 1989 report by the U.S. Treasury Department on the

effects of the possessions tax credit concluded that the exemption for QPSII

likely had little effect on total real investment in Puerto Rico. The report

noted that

“In spite of the fact that no 936 funds were available, a much higher level of real private

investment was financed in the early 1970s than in the first ten years after the enactment of

the QPSII provision. The fact that most of the fluctuations of total private investment since

1976 have been attributable to cyclical changes in inventories also suggests that the

availability of 936 funds has not had a major impact on Puerto Rican growth.”14

The simple graphical comparison in figure 6 reveals no obvious

relationship between (1) changes in exempt investment funds held in

eligible financial institutions and (2) total gross fixed investment in Puerto

Rico each year. Figure 6 shows that the balances of exempt investments in

financial institutions declined in every year after 1987, except 1992 and

13The effective date of the amendment was October 1, 1996; however, some funds that were held in the

Government Development Bank were allowed to be converted to longer maturities after that date,

under the old rules.

14U.S. Department of the Treasury, The Operation and Effect of the Possessions Corporation System of

Taxation, Sixth Report, Mar. 1989, p. 80.

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1995.15 This pattern of divestment of financial assets had no obvious

impact on the steady additions to gross fixed investment in Puerto Rico in

most years since 1987. We do not know what the year-to-year changes

have been in the financial assets that possessions corporations hold

directly.

15Part of the decline in balances since 1987 may be attributable to changes made to the possessions tax

credit by the Tax Reform Act of 1986. That act increased the share of a possessions corporation’s gross

income that has to be derived from the active conduct of a trade or business from 65 percent to

75 percent. QPSII is passive income, and some corporations may have had to reduce the amount of

that type of income they earned to meet the new requirement. Financial regulations introduced by the

government of Puerto Rico in 1988 may have been another factor contributing to the decline in exempt

investments in financial institutions. The new regulations discouraged institutions from attracting

funds from possessions corporations with the intention of investing the money outside of Puerto Rico.

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Figure 6: Gross Fixed Investment and

Changes in Exempt Investment Funds

in Eligible Financial Institutions,

1983-1996

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

(2)

0

2

4

6

8

Dollars in billion (constant 1996)

Year

Changes in exempt investment funds from previous year

Total gross fixed investment

Note: Figures were adjusted for inflation using the Puerto Rican GDP and GNP deflators. The data

on exempt investment funds for each year represent the difference between the average daily

balances for December of that year and the average daily balance for the preceding December.

Exempt investment fund data for December 1991 were not available; data for January 1992 were

used as substitutes.

Source: Government of Puerto Rico, Commissioner of Financial Institutions.

The Economic

Development

Administration of

Puerto Rico

The EDA promotes investments in Puerto Rico by local and overseas

businesses. The EDA promotions generally receive tax exemptions and

include commitments to hire and pay employees and to invest capital in

amounts negotiated between EDA and the investors. The promotions that

EDA calls “nonlocal,” (i.e., at least 50 percent of the capital invested comes

from the United States or other foreign countries) usually involve

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U.S.-owned possessions corporations. According to an EDA official, data

regarding the investment dollars, employment, and payroll committed to

these projects are likely to be an early indicator of the impact of the credit

changes on U.S. investment in Puerto Rico. Compared with the investment

data presented in figure 2, the data on investment commitments provide a

view of an earlier stage of the investment pipeline. For example,

investment dollars committed in 1996 may not appear in the government’s

final accounting of investment expenditures until 1997 or later.

The number of nonlocal promotions was greatest in 1988 when 120

businesses were promoted by EDA. Nonlocal promotions declined in most

years after 1988, with this trend of generally declining promotions

continuing after the 1993 changes in the tax credit. Nonlocal promotions

numbered 33 in 1994, the smallest number of nonlocal promotions for any

year between 1982 and 1996.

Investment committed to EDA promotions by nonlocal businesses was

greatest in the late 1980s and early 1990s but generally declined thereafter.

Investment committed to nonlocal promotions, which tended to be more

capital intensive than local promotions, reaching its highest level of

$363.5 million in 1990. This investment continued a generally declining

trend in 1994, immediately after changes in the credit, but increased

moderately in 1995 and 1996. (For more details about EDA promotions, see

app. III.)

Agency Comments

and Our Evaluation

We obtained written comments on a draft of this report from the Secretary

of the Treasury of the Commonwealth of Puerto Rico, Puerto Rico’s

Commissioner of Financial Institutions, the Acting Chairman of the Puerto

Rico Planning Board, and the Acting Administrator and Chief Executive

Officer of Puerto Rico’s Economic Development Administration. We

received oral comments on our draft from an economist from the U.S.

Department of the Treasury’s Office of Tax Analysis. Treasury’s Deputy

International Tax Counsel also reviewed the draft but had no comments.

The Secretary of the Treasury of Puerto Rico agreed that the conclusions

in our draft were generally consistent with the data we reviewed.

However, he said that the draft did not consider economic reforms

implemented by the Government of Puerto Rico since 1993, including new

incentives and initiatives to promote tourism, agriculture, research and

exports; reductions in individual and corporate income tax rates;

investments in infrastructure; and modification of financial regulations to

Page 19 GAO/GGD-97-101 Puerto Rican Economic Trends
B-276674 

reduce negative effects arising from the elimination of the credit for QPSII.

The Secretary said that the government’s “New Economic Model,” along

with the expansion of the U.S. economy, had counteracted some of the

effects of recent reductions in section 936 tax benefits. Despite these

reforms, however, the Secretary was concerned with the future of Puerto

Rico’s manufacturing sector and the need to further reduce the

commonwealth’s high unemployment rate and raise its per capita personal

income. The Secretary stated that, for these reasons, Puerto Rico needs a

revision of section 30A of the IRC that would provide federal tax benefits to

new investments in Puerto Rico; specifically a stable wage tax credit as an

incentive to U.S. manufacturing firms operating there.

We agree it is possible that recent economic initiatives of the Government

of Puerto Rico may have partially counteracted potential negative effects

of the changes in section 936. We have added language to this effect in our

final report. It was beyond the scope of our work to evaluate proposed

revisions of section 30A.

The Commissioner of Financial Institutions concurred in general terms

with the conclusions of our draft regarding exempt investment funds in

Puerto Rico. He specifically acknowledged that the level of exempt funds

in eligible financial institutions does not affect the level of investment in

Puerto Rico. The Commissioner provided additional information regarding

several factors, including a change in a commonwealth financial

regulation, that explained the trends in exempt investment funds during

1996 that we had described in our draft. He noted that corporations with

tax years ending after the middle, but before the end, of the calendar year

could take advantage of the QPSII tax benefit for a few months after

June 30, 1996. The Commissioner also noted that the Government of

Puerto Rico was implementing a capital markets reform, which, along with

it’s 1994 tax reform and a significant modernization of the

commonwealth’s legal and regulatory framework, has prepared Puerto

Rico’s financial system to be competitive, even without the QPSII benefits.

He, nevertheless, supported enhanced benefits under section 30A to help

mitigate any possible long-term adverse effects of the repeal of QPSII. We

have revised our discussion of trends in exempt investment funds to

reflect the additional information provided by the Commissioner.

The Puerto Rico Planning Board reviewed our use of their data and

provided some additional and updated data. The Planning Board also

noted several apparent discrepancies between the data that we report and

the data that they provided to us. We made some changes to reflect the

Page 20 GAO/GGD-97-101 Puerto Rican Economic Trends
B-276674 

new data provided by the Planning Board. In most cases we made no

changes where the board identified apparent discrepancies, because the

discrepancies were small and due to differences in rounding methods.

The Planning Board also commented that the year 1982, which was used

as the base year in most growth rate calculations, was a recessionary year

and that this could affect the calculation of the growth rates for GNP and

GDP per capita. We agree that the choice of base year can affect

growth-rate calculations. For example, the growth in GNP per capita would

have been slightly lower with 1981 as the base year and slightly higher

with 1983 as the base year. However, our purpose was to report trends in

the data. The growth rates were used chiefly to summarize the direction of

these trends, which was unaffected by the choice of base year.

The Planning Board also commented that caution should be used in

reporting GDP per capita because it could be misinterpreted as a measure

of the resident population’s well-being, even though it includes income

received by nonresidents of Puerto Rico. We agree and we believe that our

report clearly describes GDP per capita and distinguishes it from GNP per

capita, which is a measure of the income received by residents of Puerto

Rico.

The Planning Board provided new information on the number of

possessions corporations that received at least partial exemptions in fiscal

year 1993. They also said that IRS reported that about 474 active

possessions corporations operated in Puerto Rico for tax year 1993. After

checking with IRS, we determined that there were 474 active possessions

corporations in total. Only 455 of those corporations actually operated in

Puerto Rico. We use the updated information in this report.

The Economic Development Administration provided comments to clarify

our description of their promotions. We have incorporated their comments

in our report where appropriate.

The economist from the U.S. Treasury Department suggested minor word

changes to appendix I, which we made, where appropriate. He also

suggested that it would be of interest to have some discussion of the

spread between Eurodollar interest rates and the rates that Puerto Rican

financial institutions were offering on tax exempt funds. He said that

Treasury had found that the spreads were not significant in the late 1980s.

This would imply that the QPSII benefits may not have had a great impact

on the cost of capital in Puerto Rico. We agree that evidence of a small

Page 21 GAO/GGD-97-101 Puerto Rican Economic Trends
B-276674 

difference between Eurodollar rates and those paid on exempt funds in

Puerto Rico would imply that the QPSII provision may not have significantly

reduced the cost of capital (which, in turn, could have expanded total

investment) in Puerto Rico. An analysis that would allow us to determine

whether or not the current spreads between these rates are significant was

beyond the scope of this report.

Unless you publicly announce its contents earlier, we plan no further

distribution of this report until 30 days from the date of this letter. At that

time we will send copies of this report to the Ranking Minority Member of

the Senate Committee on Finance and to the chairmen and ranking

minority members of other appropriate congressional committees. We will

also send copies to the Secretary of the Treasury, representatives of the

Government of Puerto Rico, and other interested parties. Copies will also

be made available to others upon request.

This work was performed under the direction of James Wozny, Assistant

Director, Tax Policy and Administration Issues. Major contributors to this

report are listed in appendix VI. If you have any questions please contact

me on (202) 512-9110.

Sincerely yours,

James R. White

Associate Director, Tax Policy

 and Administration Issues

Page 22 GAO/GGD-97-101 Puerto Rican Economic Trends
Page 23 GAO/GGD-97-101 Puerto Rican Economic Trends
Contents

Letter 1

Appendix I 

Details on Changes in

the Section 936 Tax

Credit Since 1982

28

Appendix II 

Additional Details on

Puerto Rico’s

Economy

30

Domestic Net Income in Puerto Rico 30

Components of Investment in Puerto Rico 35

Employment by Economic Sector in Puerto Rico 37

Appendix III 

Information on

Economic

Development

Administration

Promotions

38

Promotions of the Economic Development Administration 38

Employment Committed to Economic Development

Administration Promotions

39

Payroll and Investment Committed to Economic Development

Administration Promotions

41

Appendix IV 

Comments From the

Secretary of the

Treasury of Puerto

Rico

45

Appendix V 

Comments From the

Commissioner of

Financial Institutions

48

Page 24 GAO/GGD-97-101 Puerto Rican Economic Trends
Contents

Appendix VI 

Comments From the

Puerto Rico Planning

Board

53

Appendix VII 

Comments From the

Economic

Development

Administration

56

Appendix VIII 

Major Contributors to

This Report

57

Tables Table II.1: Gross Fixed Private Domestic Investment, 1982-1996 36

Table II.2: Employment by Major Industrial Sector, 1982-1996 37

Figures Figure 1: Gross Domestic and Gross National Product Per Capita,

1982-1996

7

Figure 2: Public and Private Gross Fixed Investment, 1982-1996 9

Figure 3: Labor Participation and Unemployment Rates,

1982-1996

11

Figure 4: Exempt Financial Investments, 1992-1996 14

Figure 5: Exempt Investments in Eligible Financial Institutions,

by Maturity, 1992-1996

15

Figure 6: Gross Fixed Investment and Changes in Exempt

Investment Funds in Eligible Financial Institutions, 1983-1996

18

Figure II.1: Percentage Distribution of Domestic Net Income by

Employee Compensation and Property Income, 1982-1996

31

Figure II.2: Employee Compensation and Property Income in the

Manufacturing Sector, 1982-1996

33

Figure II.3: Income on Externally Held Investments, 1982-1996 35

Figure III.1: The Number of Local and Nonlocal Promotions by

the Economic Development Administration, 1982-1996

39

Page 25 GAO/GGD-97-101 Puerto Rican Economic Trends
Contents

Figure III.2: Employment Committed to Local and Nonlocal

Promotions, 1982-1996

41

Figure III.3: Investment Committed to Local and Nonlocal

Promotions, 1982-1996

43

Figure III.4: Payroll Committed to Local and Nonlocal

Promotions, 1982-1996

44

Abbreviations

EDA Economic Development Administration

GDP gross domestic product

GNP gross national product

IRC Internal Revenue Code

PRIDCO Puerto Rico Industrial Development Corporation

QPSII qualified possessions source investment income

Page 26 GAO/GGD-97-101 Puerto Rican Economic Trends
Page 27 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix I 

Details on Changes in the Section 936 Tax

Credit Since 1982

In the 1982 Tax Equity and Fiscal Responsibility Act and the 1986 Tax

Reform Act, Congress adjusted the section 936 provisions in an attempt to

reduce the ratio of federal revenue loss to employment created and

investments made in U.S. possessions. Congress principally adjusted the

tax treatment of income derived from intangible assets (such as

trademarks, patents, and trade names) and passive investments.

Before the 1982 and 1986 adjustments, corporations could (1) reduce their

U.S. income taxes by deducting from their U.S. revenues research and

development expenses that led to a patent and then (2) transfer the patent

(or other intangible asset) to Puerto Rico and realize tax-free income

under section 936 from its use in Puerto Rico. In the 1982 act, Congress

required that companies allocate some of their income realized in Puerto

Rico from intangible assets to their U.S. parent corporations. The 1986 act

changed the allocation procedures again to ensure that a greater portion of

income from intangible assets was allocated to U.S. parent corporations.

Regarding qualified possessions source income (QPSII), the 1982 act

changed the proportion of gross income that a possessions corporation

must earn from the active conduct of a possessions trade or business in

order to qualify for the section 936 credit. The act increased the proportion

from 50 to 65 percent. This, in turn, decreased the proportion of gross

income that a firm could earn from passive investments and still qualify as

a possessions corporation. The 1986 act raised the proportion again so

that a firm must derive 75 percent of its gross income from the active

conduct of a trade or business and no more than 25 percent from passive

investments.

The 1986 act also expanded the eligible activities in which QPSII funds

could be invested and still qualify for tax exemption. QPSII could now be

earned on deposits from which the Government Development Bank and

other financial institutions in Puerto Rico made loans for the acquisition or

construction of active business assets or development projects in qualified

Caribbean Basin Initiative countries.

The 1993 Budget Act limited the section 936 credit as follows. Since 1993

taxpayers were to calculate the credit as under prior law, but the credit

was capped under one of two alternative options selected by the taxpayer:

• The “percentage limitation” option provides for a decreasing credit equal

to a decreasing percentage of the amount computed under prior law. The

percentages were 60 percent in 1994, 55 percent in 1995, 50 percent in

Page 28 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix I 

Details on Changes in the Section 936 Tax

Credit Since 1982

1996, and 45 percent in 1997. The percentage was to be 40 percent in 1998

and thereafter.

• The “economic-activity limitation” option provides a cap on the credit

equal to the sum of three factors:

The first factor is 60 percent of the firm’s wages paid in the territory, plus allocable

employee fringe benefits, with wages limited for each employee to 85 percent of the

amount subject to Social Security taxes.

The second factor is a specified percentage of the firm’s depreciation deductions for each

taxable year. The type of property defines the applicable percentage: 15 percent for

property with a relatively short recovery period, 40 percent for property with a

medium-length recovery period, and 65 percent for assets with a long recovery period.

The third factor, which applies only to firms that do not use the 50-percent profit-split

method of income allocation, is a portion of the income taxes paid to the territorial

government. The taxes included, however, cannot exceed a 9 percent effective tax rate.

The Small Business Job Protection Act of 1996 repealed the tax credit for

taxable years after December 31, 1995. However, the act provides

transition rules under which a corporation that is an existing credit

claimant is eligible to claim credits with respect to possession business

income for a period lasting through taxable years beginning before

January 1, 2006. For tax years beginning after December 31, 1995, QPSII

received or accrued after June 30, 1996, may not be used in figuring the

credit.

For any taxable year beginning after December 31, 1995, and before

January 1, 2006, a corporation that was an existing credit claimant with

respect to Guam, American Samoa, or the Northern Mariana Islands may

continue to determine its credit with respect to such possession the way it

did before the 1996 act. Corporations that were existing credit claimants

with respect to Puerto Rico and the U.S. Virgin Islands may continue to

claim credits, but those credits are to be subject to income caps.16 For

taxable years beginning in 2006 and thereafter, the credit with respect to

all possessions is to be eliminated.

16The new rules for these corporations are provided in section 30A of the IRC. In order to claim a

credit for tax years after 1997, these corporations must elect the economic-activity limitation option by

tax year 1997. The income cap becomes effective for tax years beginning after December 31, 2001.

Each taxpayer’s cap is based on the average business income that the taxpayer earned in the

possession during a specific base period.

Page 29 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Congress has linked the section 936 tax credit to the development of

possessions’ economies. The credit is intended to promote investment by

U.S. corporations that leads to increased employment of the possessions’

residents. The intended increase in investment and employment should

also be reflected in the growth of income and production of the

possessions’ economies. In this appendix, we provide additional detail on

income, investment, and employment in Puerto Rico.

Domestic Net Income

in Puerto Rico

Employee Compensation

and Property Income

Domestic net income is income produced in a country. It is earned by

workers in wages and other compensation and by property owners in

profit and interest. It may also be divided into employee compensation and

property income earned by Puerto Rican residents and property income

earned by nonresidents

As shown in figure II.1, property income has been growing as a share of

net income, and the property income of nonresidents has been growing as

a share of total property income. The share of property income grew from

45.5 percent of domestic net income in 1982 to 54.6 percent in 1996, and

the share of nonresidents in total property income grew from 67.6 percent

to 73.6 percent. The result of these trends is that the share of domestic net

income earned by Puerto Rican residents from both property and

employee compensation declined from 69.3 percent to 59.8 percent

between 1982 and 1996, although residents’ income grew in absolute terms

from $16.3 billion to $23.8 billion.

Figure II.1 also shows that these trends were not interrupted by the

changes to the credit in 1993. The share of property income in domestic

net income increased between 1993 and 1996 from 53.4 percent to 54.6

percent, and the nonresident share of property income increased from 70.8

percent to 73.6 percent. In contrast, the residents’ share of total net

income continued its decline from 62.2 percent to 59.8 percent, although

the net income of Puerto Rican residents grew from $22.6 billion to

$23.8 billion.

Page 30 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Figure II.1: Percentage Distribution of Domestic Net Income by Employee Compensation and Property Income, 1982-1996

Percentage

Fiscal year

Employee compensation of residents

Property income of residents

Property income of nonresidents

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

20

40

60

80

100

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years.

Employee Compensation

and Property Income in the

Manufacturing Sector

Most of the tax benefits earned under section 936 have been earned by

corporations in the manufacturing sector.17 From 1982 through 1996, both

property income and employee compensation increased in the

manufacturing sector. However, employee compensation decreased as a

percentage of total net income in manufacturing. These trends for the

entire period also characterized the period after the changes in the credit

from 1994 through 1996.

17Puerto Rico’s tax incentives are limited largely to businesses operating in the manufacturing or

export sectors. Nonmanufacturing companies that pay the full Puerto Rican income tax can claim a

U.S. foreign tax credit for those taxes paid. Consequently, those companies receive little, if any,

additional U.S. tax reduction through section 936.

Page 31 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

As shown in figure II.2, employee compensation in the manufacturing

sector increased from $3.2 billion in 1982 to $3.6 billion in 1996. As a

percentage of domestic net income produced in the manufacturing sector,

employee compensation dropped from 35 percent to 20.2 percent. This

trend was also true between 1993 and 1996, when the share of employee

compensation declined from 23 to 20.2 percent.

The growth of property income in the manufacturing sector accounted for

a significant share of the growth in property income in the overall

economy. From 1982 through 1996, property income in Puerto Rico

increased by $11 billion, from $10.7 billion to $21.7 billion. The increase in

property income in the manufacturing sector accounted for $8.2 billion, or

74.5 percent of the overall increase. Over the same period, employee

compensation in Puerto Rico increased by $5.2 billion, from $12.8 billion

to $18 billion. The increase in employee compensation in the

manufacturing sector accounted for about $400 million, or 7.7 percent of

the overall increase.

Page 32 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Figure II.2: Employee Compensation and Property Income in the Manufacturing Sector, 1982-1996

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

5

10

15

20

Dollars in billions (constant 1996)

Fiscal year

Employee compensation 

Property income 

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflator.

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years

The growth of property income in the manufacturing sector continued to

account for a significant share of overall growth in property income after

the 1993 change to the credit. During this period, the increase in property

income in manufacturing accounted for 79.3 percent of overall growth in

property income. However, the trend in employee compensation was

different. Between 1993 and 1996, total employee compensation increased

by 6.4 percent, while employee compensation in manufacturing declined

by 2.7 percent.

Page 33 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Income From Foreign

Investment in Puerto Rico

The increasing role of nonresidents in the growth of the Puerto Rican

economy is indicated by the growth in income from the direct investments

of nonresidents in Puerto Rico. The income from direct investments is the

profit and interest income of companies operating in Puerto Rico that are

owned and controlled by nonresidents. Income from financial investments

is income from other assets owned but not controlled by nonresidents

such as dividends paid by domestic Puerto Rican companies and interest

paid by the Puerto Rican government.

As shown in figure II.3, income from the direct investment of nonresidents

grew between 1982 and 1996, both in total amount and also as a share of

all income from investments owned by nonresidents. The income from

direct investment increased from $7.6 billion in 1982 to $15.7 billion in

1996, growing at an annual rate of 5.3 percent. This income also increased

as a share of total income from investments owned by nonresidents from

87.4 percent in 1982 to 92 percent in 1996.

Figure II.3 also shows that these trends in income from the investments of

nonresidents continued after the changes to the credit in 1993. Between

1994 and 1996, income from the direct investment of nonresidents

increased from $14.4 billion to $15.7 billion, and increased as a share of

total income paid to nonresidents from 91.1 to 92 percent. 

Page 34 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Figure II.3: Income on Externally Held Investments, 1982-1996

Dollars in millions (constant 1996)

Fiscal year

Income from direct investment

Income from financial investment

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

5

10

15

20

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflator.

Source: Puerto Rico Planning Board, Balance of Payments, various years.

Components of

Investment in Puerto

Rico

Spending on machinery and equipment was the largest component of

investment in Puerto Rico between 1982 and 1996, representing on average

about two-thirds of total private investment spending. Table II.1 shows

that spending on machinery and equipment increased in most years from

about $0.8 billion in 1982 to about $3.2 billion in 1996. This represented an

annual rate of growth of 10 percent. The other components of private

Page 35 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

investment grew less rapidly. Spending on the construction of industrial

and commercial buildings grew from about $0.3 billion in 1982 to

$0.9 billion in 1996, for an annual rate of growth of 8.9 percent. Private

spending on housing construction fluctuated more from year to year than

the other components of investment. Spending on housing construction

was about $0.4 billion in 1982, climbed to $0.72 in 1991, declined to about

$0.57 billion in 1992 and 1993, and grew again to $0.97 billion in 1996.

Investment in machinery and equipment declined in 1991 and 1992

following the U.S. economic downturn, but recovered in 1993 and

continued to grow until it declined slightly in 1996. Investment in

industrial and commercial buildings fell in 1990 but grew through 1996.

Investment in housing fell in 1992 but grew in every year thereafter.

Table II.1: Gross Fixed Private

Domestic Investment, 1982-1996 Dollars in millions (constant 1996)

Year

Private housing

investment

Private industrial

and commercial

investment

Private investment

in machinery and

equipment

1982 $405.2 $269.6 $834.5

1983 362.7 221.4 921.7

1984 323.6 375.5 1,115.3

1985 391.5 333.4 1,315.2

1986 406.9 338.9 1,424.1

1987 503.6 462.2 1,669.4

1988 555.9 554.5 1,981.0

1989 580.7 595.3 2,303.9

1990 705.7 575.6 2,418.1

1991 715.9 634.2 2,395.0

1992 569.8 676.0 2,388.3

1993 574.0 775.2 2,762.0

1994 660.6 804.7 2,914.1

1995 750.9 809.7 3,224.0

1996 973.6 884.0 3,187.6

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflators for investment.

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years

Page 36 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix II 

Additional Details on Puerto Rico’s

Economy

Employment by

Economic Sector in

Puerto Rico

As Table II.2 shows, total nonagricultural employment in establishments in

Puerto Rico grew from 660,000 in 1982 to 945,000 in 1996. Over this period,

the share of manufacturing employment declined from 22.4 percent of the

total to 16.3 percent and the share of government employment fell from

36.2 percent to 32.6 percent. Manufacturing employment has actually

fallen in absolute terms since its peak in 1990. In contrast, the share of

employment in the retail trade sector rose from 12 percent to 15.8 percent

and the share of the nonfinancial service sector rose from 13.3 percent to

18.5 percent.

Table II.2: Employment by Major Industrial Sector, 1982-1996

(Numbers in thousands of persons)

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Total 660 635 665 695 709 746 796 832 841 838 844 862 879 912 945

Manufacturing 148 141 148 149 149 148 154 156 157 152 152 151 150 153 154

Mininga a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/ a/

Construction 29 23 25 28 26 32 39 44 44 44 46 47 45 46 52

Trade 110 107 112 119 124 132 142 149 154 156 155 163 171 181 188

Wholesale 31 29 30 31 30 32 35 36 37 37 37 37 36 38 40

Retail 79 77 83 89 94 100 107 113 117 119 118 126 135 143 149

Finance, Insurance & Real Estate 29 28 29 30 32 34 36 37 37 37 37 39 41 42 44

Transportation, Communication

and other Public Utilities 15 15 16 16 16 17 18 19 20 21 21 22 23 23 24

Service 88 85 88 96 100 108 117 126 132 134 139 147 157 164 175

Government 239 236 246 257 261 273 289 301 296 291 293 292 291 304 308

aTotals for mining (a/) represent numbers of less than 2,000.

Source: Puerto Rico Planning Board, Economic Report to the Governor, various years

Page 37 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

The Economic Development Administration (EDA)/ Industrial Development

Company of Puerto Rico (PRIDCO) promotes investments by local and

overseas businesses. Generally, but not always, the investments promoted

by EDA receive tax exemptions under Puerto Rican tax incentive

legislation. According to an EDA official, EDA promotions may also receive

cash grants from the government of Puerto Rico.

The EDA promotions, which are negotiated between EDA and the business

owners, include commitments to hire and pay employees and to invest

capital in specified amounts. According to an EDA official, for promotions

that receive tax incentives, EDA must be convinced that the commitments

are realistic and made in good faith. For promotions involving cash grants,

the businesses must comply with the employment commitment before the

cash is disbursed.

To receive a tax exemption, the business owners must submit an

application to the Office of Industrial Tax Exemption. This office may

recommend a grant of exemption to the Secretary of State for promotions

that also receive the endorsement of EDA, the Treasury Department, the

Environmental Office, and the municipality in which the business is

located. The tax exemption may be granted to local and nonlocal

promotions. Promotions are considered nonlocal if they receive at least

50 percent of the capital invested from the United States or other foreign

countries.

Promotions of the

Economic

Development

Administration

EDA promoted a total 2,856 businesses between 1982 and 1996. Local

promotions accounted for 1,731, or 61 percent of the total promotions. As

shown in figure III.1, local promotions outnumbered nonlocal promotions

in nearly every year between 1982 and 1996. The number of local

promotions reached their highest level of 167 businesses promoted in

1987. The number of nonlocal promotions was greatest in 1988 when 120

businesses were promoted by EDA. Nonlocal promotions declined in most

years after 1988 while local promotions declined in most years after 1990.

The trend of generally declining promotions continued after the 1993

changes in the tax credit. Local promotions numbered 84 in 1995, the

smallest number of promotions since the 81 businesses promoted by EDA

in 1982, but increased to 112 promotions in 1996. Nonlocal promotions

numbered 33 in 1994, the smallest number of nonlocal promotion for any

year between 1982 and 1996. Nonlocal promotions increased to 49 in 1995

but declined again to 44 in 1996.

Page 38 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

Figure III.1: the Number of Local and

Nonlocal Promotions by the Economic

Development Administration,

1982-1996

0

20

40

60

80

100

120

140

160

180

Number of promotions

Fiscal year

Local promotions

Nonlocal promotions

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Source: Economic Development Administration of Puerto Rico.

Employment

Committed to

Economic

Development

Administration

Promotions

Businesses promoted by EDA committed to hiring a total of 173,195

employees between 1982 and 1996. Nonlocal businesses committed to

hiring 111,206 employees, or 64 percent of the total committed

employment. As shown in figure III.2, employment committed by nonlocal

businesses exceeded commitments by local businesses in nearly every

year between 1982 and 1996. The employment commitment of nonlocal

businesses reached its highest level of 13,596 in 1988 and declined in most

years thereafter. The employment commitment of local businesses

Page 39 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

reached its highest level of 7,787 in 1986 and declined in most years after

1986.

The trend of generally declining employment commitments continued

after the 1993 changes in the credit for both local and nonlocal businesses.

Nonlocal businesses committed to hire 2,367 employees in 1994, the

smallest commitment by nonlocal businesses of any year between 1982

and 1996. Their employment commitment increased to 6,218 in 1995 but

fell again in 1996 to 3,785. Local businesses committed to hire 1,636

employees in 1995, the smallest commitment by local businesses in any

year between 1982 and 1996. Their commitment increased in 1996 to 2,913.

Page 40 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

Figure III.2: Employment Committed to

Local and Nonlocal Promotions,

1982-1996

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Number of positions committed

Local promotions

Nonlocal promotions

Fiscal year

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Source: Economic Development Administration of Puerto Rico.

Payroll and

Investment

Committed to

Economic

Development

Administration

Promotions

Between 1982 and 1996, businesses promoted by EDA committed to

investing $2.6 billion in Puerto Rico and committed to paying employees

$2.2 billion. Nonlocal businesses made the largest share of this

commitment by investing $2.2 billion, or 85 percent of the total investment

commitment, and by paying employees $1.5 billion, or 67 percent of the

total payroll commitment.

Investment committed to local and nonlocal promotions was greatest

during this period in the late 1980s and early 1990s. Figure III.3 shows that

committed investment for nonlocal promotions reached its highest level in

Page 41 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

1990 at $363.5 million, and that committed investment for local promotions

which reached its highest level of $48.6 million in 1990. Investment

committed to nonlocal promotions continued a generally declining trend

in 1994 immediately after the changes in the credit but began to rise again

in 1995 and 1996. Investment committed to nonlocal promotions fell to

$19.9 million in 1994, the smallest amount of committed investment for

any year between 1982 and 1996, but increased to $108.4 million in 1995

and $105.7 million in 1996. After increasing to $38.3 million in 1993,

investment committed to local promotions generally declined in

subsequent years.

Page 42 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

Figure III.3: Investment Committed to Local and Nonlocal Promotions, 1982-1996

Dollars in millions (constant 1996)

Investment committed to nonlocal promotions

Fiscal year

Investment committed to local promotions

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

100

200

300

400

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflator for investment in

machinery and equipment.

Source: Economic Development Administration of Puerto Rico.

Payroll committed to nonlocal promotions was generally greater in the

1980s than the 1990s. Figure III.4 shows that committed payroll for

nonlocal promotions reached its highest level in 1988 at $193.5 million.

Committed payroll for local promotions reached its highest level in 1986 at

$104.8 million. Payroll committed to nonlocal promotions continued a

declining trend in 1994 immediately after the changes to the credit when it

fell to $28.2 million, the smallest amount committed for any year between

Page 43 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix III 

Information on Economic Development

Administration Promotions

1982 and 1996. However, committed payroll increased to $77.4 million in

1995, and fell again to $46.7 million in 1996. Payroll committed to local

promotions declined in 1994 and 1995, but increased again in 1996.

As a comparison of figures III.3 and III.4 shows, nonlocal promotions

tended to be more capital intensive than the local promotions. Between

1982 and 1996, the ratio of committed payroll to investment was 1.8 to 1 in

local promotions while this ratio was 0.64 to 1 in nonlocal promotions.

Figure III.4: Payroll Committed to Local and Nonlocal Promotions, 1982-1996

Fiscal year

Dollars in millions (constant 1996)

Payroll committed to local promotions

Payroll committed to nonlocal promotions

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

0

50

100

150

200

250

Note: Figures were adjusted for inflation using the Puerto Rican GNP deflator.

Source: Economic Development Administration of Puerto Rico.

Page 44 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix IV 

Comments From the Secretary of the

Treasury of Puerto Rico

Page 45 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix IV 

Comments From the Secretary of the

Treasury of Puerto Rico

Page 46 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix IV 

Comments From the Secretary of the

Treasury of Puerto Rico

Now on p. 32.

Page 47 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix V 

Comments From the Commissioner of

Financial Institutions

Page 48 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix V 

Comments From the Commissioner of

Financial Institutions

Now on p. 2.

No longer in report.

Page 49 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix V 

Comments From the Commissioner of

Financial Institutions

Now on p. 13.

Now on p. 13.

Now on p. 16.

Page 50 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix V 

Comments From the Commissioner of

Financial Institutions

Now on p. 18.

Page 51 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix V 

Comments From the Commissioner of

Financial Institutions

Page 52 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix VI 

Comments From the Puerto Rico Planning

Board

Page 53 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix VI 

Comments From the Puerto Rico Planning

Board

Now on p. 4.

Now on p. 6.

Now on pp. 11 and 37.

Now on p. 12.

Page 54 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix VI 

Comments From the Puerto Rico Planning

Board

Page 55 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix VII 

Comments From the Economic

Development Administration

Now on p. 18.

Now on p.18.

Page 56 GAO/GGD-97-101 Puerto Rican Economic Trends
Appendix VIII 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

James A. Wozny, Assistant Director, Tax Policy and Administration Issues

Kevin E. Daly, Economist-in-Charge

Eric Hall, Computer Specialist

(268789) Page 57 GAO/GGD-97-101 Puerto Rican Economic Trends
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