a

GAO

United States Government Accountability Office

On June 14, 2006, the PDF file was revised to show on page 65, third 

paragraph: $4.2 million rather than $3,755 for pharmaceuticals CFCs 

incorporated outside of Puerto Rico, $1.6 million rather than $1,465 for 

pharmaceuticals CFCs incorporated in Puerto Rico, and $0.9 million rather 

than $801 for possessions corporations in the pharmaceutical industry.

Report to the Chairman and Ranking 

Minority Member, Committee on 

Finance, U.S. Senate

May 2006 PUERTO RICO

Fiscal Relations with 

the Federal 

Government and 

Economic Trends 

during the Phaseout of 

the Possessions Tax 

Credit

GAO-06-541
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

May 2006

PUERTO RICO

Fiscal Relations with the Federal 

Government and Economic Trends 

during the Phaseout of the Possessions 

Tax Credit 

Highlights of GAO-06-541, a report to 

Committee on Finance, U.S. Senate 

The federal possessions tax credit, 

which was designed to encourage 

U.S. corporate investment in

Puerto Rico and other insular 

areas, expires this year. 

Proponents of continued federal 

economic assistance to Puerto Rico

have presented a variety of

proposals for congressional

consideration.

In response to a request from the 

U.S. Senate Committee on Finance,

this study compares trends in

Puerto Rico’s principal economic

indicators with those for the United

States; reports on changes in the 

activities and tax status of the 

corporations that have claimed the 

possessions tax credit; explains 

how fiscal relations between the 

federal government and Puerto

Rico differs from the federal 

government’s relations with the 

states and other insular areas; and 

compares the taxes paid to all 

levels of government by residents 

of Puerto Rico, the states, and

other insular areas. 

GAO used the latest data available 

from multiple federal and Puerto 

Rican government agencies. Data

limitations are noted where

relevant. Key findings are based on 

multiple measures from different 

sources. GAO is not making any 

recommendations in this report. 

In comments on this report the 

Governor of Puerto Rico said the 

report will be useful for evaluating

policy options. 

Puerto Rico’s per capita gross domestic product (GDP, a broad measure of 

income earned within the Commonwealth) in 2005 was a little over half of 

that for the United States (see figure below). Puerto Rico’s per capita gross 

national product (GNP, which covers income earned only by residents of the 

Commonwealth) was even lower relative to the United States. Concerns 

about Puerto Rico’s official price indexes make it difficult to say whether the 

per capita GNP of Puerto Rican residents has grown more rapidly than that 

of U.S. residents; however, the absolute gap between the two has increased. 

U.S. corporations claiming the possessions tax credit dominated Puerto 

Rico’s manufacturing sector into the late 1990s. After the tax credit was 

repealed in 1996 beginning a 10-year phaseout period, the activity of these 

corporations decreased significantly. Between 1997 and 2002 (the latest data 

available) valued added in these corporations decreased by about two-thirds. 

A variety of data indicates that much of this decline was offset by growth in 

other corporations, so that some measures of aggregate activity remained 

close to their 1997 levels. For example, value added in manufacturing 

remained fairly constant between 1997 and 2002. Most of the offsetting 

growth was in the pharmaceutical industry. 

Residents of Puerto Rico pay considerably less total tax per capita than U.S. 

residents. However, because of lower incomes they pay about the same 

percentage of their personal income in taxes. The composition of taxes 

differed between Puerto Rico and the states with federal taxes being a larger 

share of the total in the states. This difference reflects the facts that (1) 

residents of Puerto Rico generally do not pay federal income tax on income 

they earn in the Commonwealth and (2) the Commonwealth government has 

a wider range of responsibilities than do U.S. state and local governments. 

U.S. and Puerto Rican Real Per Capita GDP and GNP, 1980–2005 

Dollars (constant 2005)

Source: GAO analysis of U.S. Bureau of Economic Analysis and Puerto Rican Planning Board data.

Fiscal year

U.S. GDP

U.S. GNP

Puerto Rican GNP (U.S. deflator)

Puerto Rican GNP (Puerto Rican deflator)

Puerto Rican GDP (Puerto Rican deflator)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

199

1999

2000

2001

2002

2003

2004

2005

8

19

1990

1991

1992

1993

1994

1995

1996

1997

89

1988

1987

1986

1985

1984

1983

1982

1981

1980

www.gao.gov/cgi-bin/getrpt?GAO-06-541.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact James White at 

(202) 512-9110 or whitej@gao.gov. 
Page i GAO-06-541 Puerto Rican Fiscal and Economic Trends

Contents

Letter 1

Executive Summary 2

Purpose 2

Background 3

Scope and Methodology 7

Results in Brief 10

Principal Findings 12

Agency Comments 25

Chapter 1

Introduction

26

Background 27

Possessions Tax Credit 29

Scope and Methodology 32

Chapter 2

U.S. Federal Tax 

Treatment of Puerto 

Rico and Other Insular 

Areas Varies by Area 

and Type of Tax

41

U.S. Tax Treatment of Insular Area Residents with U.S.-source 

Income and U.S. Residents with Insular Area-source Income 

Varies by Area 41

While FICA Taxes Are Imposed on Wages Paid to Employees in All 

Insular Areas, Unemployment Insurance Tax Applies Only to 

Wages Paid in Puerto Rico and U.S. Virgin Islands 42

Taxation of Corporations Incorporated in the United States 43

Taxation of Corporations Incorporated outside the United States 44

Deduction for Income from Domestic Production Activities 45

Goods Imported to Insular Areas Are Generally Exempt from U.S. 

Excise Taxes, but a Special Tax Is Imposed on Goods Made in 

Puerto Rico and U.S. Virgin Islands 46

U.S. Government Is Responsible for Collecting Customs Duties in 

Puerto Rico and Helps Collect Duties in U.S. Virgin Islands 47

Chapter 3

Trends in Production, 

Income, and Other 

Economic Indicators 

for Puerto Rico

48

Measuring Economic Progress in Puerto Rico Is Challenging but the 

Income of Commonwealth Residents Remains Well Below That of 

U.S. Residents 48

Puerto Rico Relies Heavily on Nonresidents to Finance Local 

Investment 52

Data on Value Added and Income Show That the Pharmaceuticals 

Industry Has Significantly Increased Its Dominance of Puerto 

Rican Manufacturing but Evidence Suggests That These Measures 
Contents

Page ii GAO-06-541 Puerto Rican Fiscal and Economic Trends

May Be Overstated 60

International Trade Plays a Large Role in Puerto Rico’s

Economy 68

Official Statistics Indicate That Unemployment Has Been Much 

Higher in Puerto Rico Than in the United States and Labor Force 

Participation Has Been Lower 69

Since 1980, Real Per Capita Personal Income in Puerto Rico Has Not 

Grown Enough to Substantially Reduce the Gap between U.S. and 

Puerto Rican Living Standards 76

Chapter 4

Much Possessions 

Corporation Activity 

Has Shifted to 

Affiliated Corporations

80

Possessions Corporations Dominated Puerto Rico’s Manufacturing 

Sector up until the Late 1990s 80

The Pharmaceutical Industry Has Dominated the Use of the 

Possessions Tax Credit in Puerto Rico 84

Businesses Have a Variety of Options for Continuing Operations in 

Puerto Rico after They Cease Operating as Possessions 

Corporations 86

Some Measures of Aggregate Manufacturing Activity Have 

Remained Constant Despite a Decline in Possessions Corporation 

Activity 90

Chapter 5

U.S. Businesses 

Dominated Puerto 

Rican Manufacturing in 

2002 but Played 

Smaller Roles in Other 

Sectors

101

U.S. CFCs Have Become the Most Important Type of Business Entity 

in Puerto Rico’s Manufacturing Sector in Terms of Value Added 

but Not in Terms of Employment 101

The Role of U.S. Corporations Is Much Smaller in Puerto Rico’s 

Wholesale and Retail Trade Than in Manufacturing 106

Neither Possessions Corporations nor CFCs Were Significant 

Employers in 2002 in Most Puerto Rican Service Industries for 

Which Data Are Available 108

Chapter 6

Taxes Per Capita in 

Puerto Rico Are Lower 

Than in the States but 

Are about the Same 

Share of Income

110

Taxes Paid Per Capita in Puerto Rico Are Lower Than Those in the 

States but the Taxes Are about the Same Share of Personal 

Income in Both Places 110

Income and Employment Taxes Account for about Two-thirds of the 

Taxes Paid in Both Puerto Rico and the States, but the Allocation 

of Those Taxes by Level of Government Differs between the Two 

Locations 113
Contents

Page iii GAO-06-541 Puerto Rican Fiscal and Economic Trends

Puerto Rico’s Outstanding Government Debt in 2002 Was Much 

Higher Than That of State and Local Governments as a Share of 

Personal Income, Partly Because the Commonwealth 

Government Has a Wider Range of Responsibilities 115

Federal Grants and Payments to Governments Per Capita Are the 

Same for Puerto Rico and the States but Direct Federal Payments 

to Individuals Per Capita Are Significantly Lower in 

Puerto Rico 118

Chapter 7

The Extent That 

Federal Social 

Programs in Puerto 

Rico Mirror Those in 

the States and Other 

U.S. Insular Areas 

Varies

123

Comparison of Selected Federal Social Programs 123

Appendixes

Appendix I: Methodology for Allocating the Assets and Liabilities of 

Depository Banks by Geographic Location 126

Appendix II: Additional Information on Puerto Rican Economic Trends 

and Capital Flows 130

A Comparison of Rates of Return for Possessions Corporations and 

Controlled Foreign Corporations (CFC) in Puerto Rico’s Chemical 

Industry 138

Appendix III: Methodology for Analyses of Business Activities 143

Appendix IV: Additional Data on Possessions Corporations and Their 

Affiliates 146

Appendix V: Additional Data on the Distribution of Business Activity by 

Type of Business Entity 153

Appendix VI: Additional Comparative Fiscal Data 170

Appendix VII: Additional Details on the Application of Federal Social 

Programs 172

Education Programs 172
Contents

Page iv GAO-06-541 Puerto Rican Fiscal and Economic Trends

Food and Nutrition Programs 174

Health Care Financing and Grants Programs 179

Income Assistance Programs 188

Programs for the Care of Children 190

Housing Programs 193

Appendix VIII: U.S. Gross Domestic Product Deflator and Puerto Rican 

Gross Product Deflator, 

1980–2005 206

Appendix IX: Agency Comments 207

Appendix X: GAO Contact and Staff Acknowledgments 210

Tables Table 1: Summary of Selected Social Programs in Puerto Rico 

Compared to Those in the States 24

Table 2: Demographic Characteristics of Puerto Rico Compared to 

the United States 29

Table 3: Recent and Forthcoming Reports on Puerto Rico 32

Table 4: Educational Attainment in the U.S. and Puerto Rico, 1990 

and 2000 72

Table 5: Poverty Status in the United States and Puerto Rico, 

Percentage below Poverty Levels, 1999 78

Table 6: Income Distribution of Households in the United States 

and Puerto Rico, 1999 79

Table 7: Distribution of Employment by Business Entity Type for 

the Six Largest Services Included in the 2002 Economic 

Census of Puerto Rico 109

Table 8: Federal Expenditures in Fiscal Year 2002 120

Table 9: Federal Custom Duties and Excise Taxes Returned to 

Puerto Rico in Fiscal Year 2002 122

Table 10: Comparison of Selected Social Programs in the U.S. Insular 

Areas to Those in the States 124

Table 11: Allocation of Balance Sheet Items by Geographic 

Location 127

Table 12: Percent of Discrepancies by Line Item (percent) 129

Table 13: The Source and Use of Funds for Selected Financial 

Institutions in Puerto Rico 136

Table 14: Selected Data for the Full Population of Possessions 

Corporations Operating in Puerto Rico, 1993–2003 146

Table 15: Selected Data for Large Corporate Groups Operating in 

Puerto Rico, by Type of Entity, 1993–2003 147
Contents

Page v GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 16: Selected Data for Large Corporate Groups Operating in the 

Chemical and Medical Equipment Industries in Puerto 

Rico, by Type of Entity, 1993–2003 148

Table 17: Selected Data for Large Corporate Groups Operating in the 

Computer, Electronics, and Electrical Equipment 

Industries in Puerto Rico, by Type of Entity, 

1993–2003 149

Table 18: Selected Data for Large Corporate Groups Operating in the 

Food and Kindred Products Industries in Puerto Rico, by 

Type of Entity, 1993–2003 150

Table 19: Distribution of Tax Credits, Income, and Assets of 

Possessions Corporations Operating in Puerto Rico, by 

Industry, 1993–2003 151

Table 20: Employment in Puerto Rican Manufacturing by Industry 

and Business Entity Type, 2002 154

Table 21: Value Added in Puerto Rican Manufacturing by Industry 

and Business Entity Type, 2002 156

Table 22: Annual Payroll in Puerto Rican Manufacturing by Industry 

and Business Entity Type, 2002 158

Table 23: Capital Expenditures in Puerto Rican Manufacturing by 

Industry and Business Entity Type, 2002 160

Table 24: Value of Shipments in Puerto Rican Manufacturing by 

Industry and Business Entity Type, 2002 162

Table 25: Share of Employment for Puerto Rico’s Manufacturing, 

Wholesale Trade, Retail Trade, and Services Sectors in 

2002 164

Table 26: Share of Sales and Value of Shipments for Puerto Rico’s 

Manufacturing, Wholesale Trade, Retail Trade, and 

Services Sectors in 2002 166

Table 27: Share of Payroll for Puerto Rico’s Manufacturing, 

Wholesale Trade, Retail Trade, and Services Sectors in 

2002 168

Table 28: Federal, State, Commonwealth, and Insular Area Revenues 

Collected in Fiscal Year 2002 170

Table 29: Special Education Grant Allocation to, and Number of 

Students Covered by IDEA Part B in, the States and Puerto 

Rico Authorized by IDEA Part B, Fiscal Year 2002 173

Table 30: Title I Grant Allocation and Number of Covered Students, 

Fiscal Year 2002 174

Table 31: Comparison of the Food Stamp and Nutrition Assistance 

Programs 176
Contents

Page vi GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 32: National School Lunch Program Reimbursement Rates, 

School Year 2003–2004 178

Table 33: Estimated Food and Nutrition Program Federal 

Expenditures for the States, Puerto Rico, and the Other 

U.S. Insular Areas, Fiscal Year 2003 179

Table 34: Estimated Medicare Enrollment and Expenditures as of 

July 2003, Fiscal Year 2003 180

Table 35: Estimated Medicaid Enrollment and Federal 

Expenditures, Fiscal Year 2004 182

Table 36: Estimated SCHIP Enrollment and Federal Allotments, 

Fiscal Year 2004 185

Table 37: Population and Estimated Grant Awards from Four Health 

and Human Service Agencies, Fiscal Year 2004 187

Table 38: Comparison of Selected Data on TANF Program in Puerto 

Rico to TANF Program in the States, Fiscal Year 2003 190

Table 39: Child Care and Development Fund Expenditures and 

Children Served, Fiscal Year 2003 191

Table 40: Estimated Child Welfare Population, Fiscal Year 2001 192

Table 41: Estimated Federal Foster Care and Adoption Assistance 

Funding, Fiscal Year 2003 193

Table 42: Estimated Amount and Percent of Total Operating Subsidy 

Received by the Five Largest Public Housing Authorities, 

Fiscal Year 2002 195

Table 43: Total Number and Percent of Public Housing Units for the 

Five Largest Public Housing Authorities, Fiscal Year 

2005 195

Table 44: Number of Housing Choice Vouchers and Estimated 

Budget Authority in Puerto Rico and Selected States and 

Insular Areas, Fiscal Year 2003 197

Table 45: Estimated Disbursement of CDBG Funds for Housing, 

Fiscal Years 2001–2004 199

Table 46: Estimated Amount of HOME Grants for Puerto Rico and 

the Other Insular Areas, Fiscal Year 2005 203

Figures Figure 1: U.S. and Puerto Rican Real Per Capita GDP and GNP, 

1980–2005 14

Figure 2: Value Added for Possessions Corporations and Other 

Types of Employers in the Chemical Industry and All 

Other Manufacturing Industries, 1997–2002 17

Figure 3: Capital Expenditures in Puerto Rico’s Manufacturing 

Sector, by Industry, 1987–2002 18
Contents

Page vii GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 4: Employment in Possessions Corporations and Other 

Types of Employers in the Chemical Industry and All 

Other Manufacturing Industries, 1997–2002 19

Figure 5: Distribution of Value Added for All Puerto Rican 

Manufacturing by Type of Business Entity, 2002 20

Figure 6: Distribution of Employment for All Puerto Rican 

Manufacturing by Type of Business Entity, 2002 21

Figure 7: Per Capita Taxes Paid in the United States and Insular 

Areas, Fiscal Year 2002 22

Figure 8: Taxes Paid as a Share of Personal Income in the United 

States and Insular Areas, Fiscal Year 2002 23

Figure 9: U.S. and Puerto Rican Per Capita GDP and GNP, 1980–

2005 51

Figure 10: Composition of Puerto Rican GDP and Net Income 

Payments Abroad, 1980–2005 52

Figure 11: Puerto Rico’s Gross Domestic Investment and National 

Saving, 1980–2005 53

Figure 12: Puerto Rico’s Depository Institutions’ Liabilities, 1995–

2004 55

Figure 13: Puerto Rico’s Depository Institutions’ Assets, 

1995–2004 56

Figure 14: Puerto Rico’s Total Real Government-issued Debt, by 

Market of Purchaser, 1995–2005 57

Figure 15: Puerto Rican Gross Fixed Investment as a Percent of 

GDP, 1980–2005 58

Figure 16: Puerto Rico’s Capital Expenditures as a Percentage of 

Gross Domestic Product, 1987–2002 60

Figure 17: Value Added for Puerto Rican Manufacturing Industries, 

1987–2002 61

Figure 18: Share of Net Manufacturing Domestic Income in Puerto 

Rico, 1980–2005 62

Figure 19: Shares of Puerto Rico’s Domestic Income by Sector, 

1980–2005 63

Figure 20: Value Added per Employee for Key Puerto Rican 

Manufacturing Industries, 1987–2002 66

Figure 21: Value Added per Employee in Puerto Rico by Type of 

Business, 2002 67

Figure 22: U.S. and Puerto Rican Labor Participation and 

Unemployment Rates, 1980–2005 69

Figure 23: Puerto Rican Employment by Sector—Household Survey, 

1980–2005 74
Contents

Page viii GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 24: Puerto Rican Employment by Sector—Establishment 

Survey, 1991–2005 75

Figure 25: Employment in Puerto Rican Manufacturing Industries, 

1987–2002 76

Figure 26: U.S. and Puerto Rican Real Per Capita Personal Income, 

1980–2005 77

Figure 27: Share of Possessions Corporations in Value Added and 

Employment in Puerto Rican Manufacturing, 

1987–2002 81

Figure 28: Income and Assets from the Tax Returns of Possessions 

Corporations Operating in Puerto Rico, 1993–2003 82

Figure 29: The Ratio of Possessions Tax Credit to Total Income 

Earned by Possessions Corporations in Puerto Rico, 

1993–2003 83

Figure 30: The Number of Corporations in Puerto Rico Claiming the 

Possessions Tax Credit and the Amount Claimed, 1993–

2003 84

Figure 31: Industry Shares of the Possessions Tax Credit in Puerto 

Rico, 1993–2003 85

Figure 32: Industry Shares of Gross Profits Earned by Possessions 

Corporations in Puerto Rico, 1993–2003 86

Figure 33: Gross Profits Earned by Large Corporate Groups in 

Puerto Rico, by Type of Corporation, 1993–2003 92

Figure 34: Value Added for Possessions Corporations and Other 

Types of Employers in Manufacturing in Puerto Rico, 

1987–2002 94

Figure 35: Value Added for Possessions Corporations and Other 

Types of Employers in the Chemical Industry and All 

Other Manufacturing Industries in Puerto Rico, 1997–

2002 95

Figure 36: Capital Expenditures in Puerto Rico’s Manufacturing 

Sector, by Industry, 1987–2002 97

Figure 37: Employment in Possessions Corporations and Other 

Types of Employers in Manufacturing in Puerto Rico, 

1987–2002 99

Figure 38: Employment in Possessions Corporations and Other 

Types of Employers in the Chemical Industry and All 

Other Manufacturing Industries in Puerto Rico, 1997–

2002 100

Figure 39: Distribution of Value Added for All Puerto Rican 

Manufacturing by Type of Business Entity, 2002 102
Contents

Page ix GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 40: Distribution of Employment for All Puerto Rican 

Manufacturing by Type of Business Entity, 2002 103

Figure 41: Distribution of Income in 2001 between CFCs 

Incorporated in Puerto Rico and CFCs Incorporated 

Elsewhere 104

Figure 42: Value Added in the Pharmaceutical Industry by Type of 

Business Entity, 2002 105

Figure 43: Value Added in Manufacturing, Excluding 

Pharmaceuticals, by Type of Business Entity, 2002 106

Figure 44: Share of Employment in Wholesale Trade in Puerto Rico 

by Type of Business Entity, 2002 107

Figure 45: Share of Employment in Retail Trade in Puerto Rico by 

Type of Business Entity, 2002 108

Figure 46: Per Capita Taxes Paid in the United States and Insular 

Areas, Fiscal Year 2002 111

Figure 47: Taxes Paid as a Share of Personal Income in the United 

States and Insular Areas, Fiscal Year 2002 112

Figure 48: The Composition of Taxes Paid in Puerto Rico, Fiscal 

Year 2002 114

Figure 49: The Composition of Taxes Paid in the States, Fiscal Year 

2002 115

Figure 50: Per Capita Government Debt in the United States and 

Insular Areas, Fiscal Year 2002 116

Figure 51: Government Debt as a Share of Personal Income in the 

United States and Insular Areas, Fiscal Year 2002 117

Figure 52: Puerto Rico’s Depository Institutions’ Deposits, 1995–

2004 130

Figure 53: Puerto Rico’s Depository Institutions’ Debt, 

1995–2004 131

Figure 54: Exempt Deposits of Possessions Corporations and 

Brokered Deposits in Puerto Rican Banks, 1997–2004 132

Figure 55: Puerto Rico’s Depository Institutions’ Securities 

Investments, 1995–2004 133

Figure 56: Puerto Rico’s Depository Institutions’ Loans and Leases, 

1995–2004 134

Figure 57: Assets of Selected Financial Institutions in Puerto Rico, 

1995–2004 135

Figure 58: Real Debt Issued by the Government of Puerto Rico, but 

Payable from Private or Federal Funds, or Asset Sales, by 

Market of Purchaser, 1995–2005 137

Figure 59: Real Debt Issued and Payable by the Government of 

Puerto Rico, by Market of Purchaser, 1995–2005 138
Contents

Page x GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 60: Rates of Return on Total Assets for Possessions 

Corporations and CFCs in the Chemical Industry, Puerto 

Rico, 1997, 1999, 2001 139

Figure 61: Rates of Return on Operating Assets for Possessions 

Corporations and CFCs in the Chemical Industry, Puerto 

Rico, 1997, 1999, 2001 140

Figure 62: Composition of Assets of the Possessions Corporations 

of All Large Groups, Puerto Rico, 1993–2003 142

Abbreviations

AABD Aid to the Aged, Blind, or Disabled 

BEA Bureau of Economic Analysis 

BLS Bureau of Labor Statistics 

CACFP Child and Adult Care Food Program 

CCDF Child Care and Development Fund 

CDBG HUD’s Community Development Block Grant Program 

CDC Centers for Disease Control and Prevention 

Census U.S. Census Bureau 

CFCs controlled foreign corporations 

CMS Centers for Medicare & Medicaid Services 

CNMI Commonwealth of the Northern Mariana Islands 

CPI consumer price index 

CPL Commonwealth poverty level 

CPS Current Population Survey 

EIN employer identification number 

EPSDT early and periodic screening, diagnostic, and treatment 

ETI extraterritorial income 

FHA Federal Housing Administration 

FICA Federal Insurance Contributions Act 

FPL federal poverty level 

GDP gross domestic product 

GNP gross national product 

HHS Department of Health and Human Services 

HRSA Health Resources and Services Administration 

HUD Department of Housing and Urban Development 

IDEA Individuals with Disabilities Education Act 

IEP individualized education programs 

IRC Internal Revenue Code 

IRS Internal Revenue Service 

LLC limited liability company 
Contents

Page xi GAO-06-541 Puerto Rican Fiscal and Economic Trends

NAP IRS’s National Accounts Profile 

NAP Nutrition Assistance Program (the Puerto Rican food stamp 

program) 

NIH National Institutes of Health 

NOFA Notices of Funding Availability 

NSLP National School Lunch Program 

OCFI Office of the Commissioner of Financial Institutions 

PHA public housing authorities 

PPS prospective payment system 

PRIDCO Puerto Rico Industrial Development Company 

PRPHA Puerto Rico Public Housing Administration 

PRWORA Personal Responsibility and Work Opportunity Reconciliation 

Act of 1996 

QPSII qualified possession source investment income 

SAMHSA Substance Abuse and Mental Health Services Administration 

SCHIP State Children’s Health Insurance Program 

SOI IRS’s Statistics of Income unit 

SSI Supplemental Security Income 

TANF Temporary Assistance for Needy Families 

USDA United States Department of Agriculture 

WIC Special Supplemental Nutrition Program for Women, Infants, 

and Children

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately.
Contents

Page xii GAO-06-541 Puerto Rican Fiscal and Economic Trends
Page 1 GAO-06-541 Puerto Rican Fiscal and Economic Trends

United States Government Accountability Office

Washington, D.C. 20548

A

May 19, 2006 Letr

The Honorable Charles E. Grassley

Chairman

The Honorable Max Baucus

Ranking Minority Member

Committee on Finance

United States Senate

In response to your request, this report provides information on the Puerto 

Rican economy, including corporate activity, during the phaseout of the 

possessions tax credit, as well as descriptions of the application of federal 

tax law and federal social policy programs in Puerto Rico. 

As we agreed with your office, unless you publicly announce the contents 

of this report earlier, we plan no further distribution of it until 30 days from 

the date of this letter. We will then send copies to the Governor's office in 

Puerto Rico, Resident Commissioner Fortuno, and other interested parties. 

We will also make copies available to others who request them. This report 

will also be available at no charge on the GAO Web site at 

http://www.gao.gov. If you or your staffs have any questions on this report, 

please call me on (202) 512-9110. Key contributors are listed in appendix X.

James R. White

Director, Tax Issues

Strategic Issues Team
Page 2 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Executive Summary

Purpose For the past 30 years, the U.S. Tax Code has provided a possessions tax 

credit specifically designed to encourage U.S. corporations to invest in 

Puerto Rico and the other U.S. insular areas and create jobs.1 The credit 

had the effect of reducing federal taxes on income earned by qualifying U.S. 

corporations. Congress repealed the credit in 1996, but allowed existing 

credit claimants to continue use of the credit during a 10-year phaseout 

period ending in 2006.2

As the expiration date of the credit approached, Congress naturally became 

interested in reviewing the effects of the phaseout, particularly on the 

Puerto Rican economy, where over 98 percent of the credit has been 

claimed. At the same time, proponents of continued economic assistance to 

Puerto Rico have offered up a variety of proposals, including tax incentives 

to both businesses and low income workers, for congressional 

consideration. Congress could better assess the merits of the various 

proposals if it had more complete information relating to the current 

treatment that Puerto Rico receives under both federal tax policies and 

federal social programs, and information relating to the taxes paid by 

residents of Puerto Rico, relative to those paid by residents of the states 

and the other U.S. insular areas.3

To help inform itself and other members of Congress as they decide on 

future policy toward Puerto Rico, the Senate Committee on Finance asked 

GAO to 

1. explain how the U.S. federal tax treatment of individuals and 

businesses in Puerto Rico and of the insular government differs relative 

to the treatment of governments, businesses, and individuals in the 

states and the other U.S. insular areas;

1

In this report, GAO refers to the three major U.S. territories, the U.S. Virgin Islands, 

American Samoa, and Guam, and the two Commonwealths, the Commonwealth of Puerto 

Rico and the Commonwealth of the Northern Mariana Islands (CNMI), as “the insular 

areas.” 

2

The Small Business Job Protection Act of 1996, Pub. L. No. 104-188 (1996), repealed the 

credit fully for tax years beginning after December 31, 2005, following a 10-year phaseout 

period.

3

In this report, GAO refers to the 50 states and the District of Columbia as “the states.”
Executive Summary

Page 3 GAO-06-541 Puerto Rican Fiscal and Economic Trends

2. compare trends in Puerto Rico’s principal economic indicators since 

the early 1980s with similar indicators at the national level for the 

United States and describe what is known about capital flows between 

Puerto Rico and the United States and between Puerto Rico and foreign 

countries;

3. report on changes in the activities and tax status of the corporations 

that have claimed the possessions tax credit since 1993; 

4. provide information on the distribution of private-sector economic 

activity in Puerto Rico by type of business entity; 

5. describe the total amount of tax paid by individuals and businesses in 

the states and the U.S. insular areas and show percentage breakdowns 

by type of tax; and

6. describe how the principal U.S. federal social programs apply to Puerto 

Rican residents relative to residents of the states and the other U.S. 

insular areas. 

This report does not contain any recommendations. Members of the Senate 

Committee on Finance have asked the Joint Committee on Taxation to 

prepare a companion report evaluating legislative options concerning 

Puerto Rico. 

Background This report focuses on the Commonwealth of Puerto Rico, the largest 

insular area associated with the United States, and compares Puerto Rico 

to the states and the other insular areas—Guam, the U.S. Virgin Islands, the 

Commonwealth of the Northern Mariana Islands (CNMI), and American 

Samoa. Although fiscally autonomous, Puerto Rico is similar to the states 

in many aspects. For example, matters of currency, interstate commerce, 

and defense are all within the jurisdiction of the U.S. federal government. 

Puerto Rico is thought to have one of the most dynamic economies in the 

Caribbean region, an economy in which manufacturing, driven by the 

pharmaceutical industry, has surpassed agriculture as the primary sector in 

terms of domestic income. Over 40 percent of Puerto Rico’s domestic 

income since the mid-1980s has been derived from manufacturing. 

Pharmaceuticals accounted for about 40 percent of total value added in 

manufacturing in 1987; that share rose to over 70 percent by 2002.
Executive Summary

Page 4 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The Tax Reform Act of 19764 established the possessions tax credit under 

Section 936 of the Internal Revenue Code (IRC), with the stated goal of 

assisting the insular areas in “obtaining employment-producing investment 

by U.S. corporations.”5

 Prior to 1994, the tax credit was equal to the full 

amount of the corporation’s U.S. income tax liability on income from an 

insular area. The amount of possession tax credit claimed by corporations 

operating in Puerto Rico peaked at about $5.8 billion in 1993.6

 A series of 

limits were placed on the credit beginning with 1994 tax years, which 

significantly reduced the generosity of the credit throughout the period 

leading up to the credit’s final expiration for tax years beginning after 

December 31, 2005.7

Numerous measures of business activity and broader economic activity 

exist. Some broad measures that are commonly recognized as key 

indicators of aggregate economic activity and were included in our past 

review of Puerto Rico’s economy are8

4

Pub. L. No. 94-455 (1976).

5

The Internal Revenue Code (IRC) has included each of the insular areas in its definition of 

U.S. “possessions” for the purposes of the tax credits governed by Sections 936 and 30A of 

the IRC. Following the IRC and Internal Revenue Service (IRS) forms and publications, GAO 

uses the terms “possessions corporations” and “possessions income” to refer to 

corporations and income covered by these credits. GAO also uses the term “possessions tax 

credit” as shorthand to cover both the Puerto Rico and possessions tax credit and the 

Puerto Rico economic activity credit, which were claimed by possessions corporations 

operating in Puerto Rico during different periods covered by this report.

6

All dollar figures in the trend analyses from chs. 3 and 4 of this report are adjusted for 

inflation to reflect the value of a dollar as of 2005. The data that we report from the U.S. 

Census Bureau (Census) and other sources for 2002 in chs. 5 and 6 were left in 2002 dollars 

to make it easier for readers to use our results in conjunction with Census’s publications.

7

The Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66 (1993), limited the 

credit for tax years beginning after December 31, 1993. Those corporations whose tax years 

begin before January 1 may still claim the credit during the 2006 calendar year. For example, 

a corporation whose latest tax year began December 1, 2005 may claim the credit on income 

earned through November 30, 2006.

8

GAO, Tax Policy: Puerto Rican Economic Trends, GAO/GGD-97-101 (Washington, D.C.: 

May 14, 1997).
Executive Summary

Page 5 GAO-06-541 Puerto Rican Fiscal and Economic Trends

• employment; 

• investment, which is spending devoted to projects producing goods that 

are not intended for immediate consumption;9

• gross domestic product (GDP), which is a comprehensive measure of 

income earned by both residents and nonresidents within a country’s 

(or, in the case of Puerto Rico, a Commonwealth’s) borders;10 and 

• gross national product (GNP), which is the total income earned by 

residents of a country or other entity. 

Measures that focus more specifically on business activity or value are 

• value added, which essentially is the difference between the value of the 

goods and services produced by a firm and the firm’s payments for 

materials, supplies, energy, and contract work, and which is considered 

to be the best measure of the relative economic importance of 

manufacturing across industries and geographic areas;

• gross profits, which, in the case of manufacturing firms, is roughly 

equivalent to value added and which is available from tax returns 

(whereas value added is not);

• total income, which is the sum of gross profits plus various types of 

investment income, such as interest, dividends, rents, and royalties; 

• net income, which is total income less all expenses; and

• total assets, which is the sum of the value of a business’s physical assets 

(plant, machinery, land, inventories), financial assets (cash, accounts 

receivable, investments), intangible assets (patents and other 

intellectual property), and other assets.

To qualify for the possessions tax credit, a corporation has to be organized 

in the United States; derive 80 percent or more of its gross income from 

9

Capital expenditures (i.e., spending on buildings and equipment) is a significant component 

of investment.

10GDP can also be measured as the total value of goods and services produced within a 

country’s borders.
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Page 6 GAO-06-541 Puerto Rican Fiscal and Economic Trends

U.S. possessions; derive 75 percent or more of its gross income from the 

active conduct of a trade or business in the possessions; and file a form 

with the IRS electing to be treated as a possessions corporation. As a result 

of these requirements, possessions corporations usually are established as 

subsidiaries of a U.S. corporate parent, making the possessions 

corporation a member of a corporate group. In addition, one option under 

the credit allowed the U.S. corporate parent and the possessions 

corporation to apply a 50/50 split of their combined taxable income from 

the sale of products to third parties. Although a substantial portion of this 

income can be attributed to manufacturing intangible assets developed and 

owned by the U.S. corporate parent, there is no requirement that the 

allocation of income from such manufacturing intangible assets reflect 

where costs were actually generated, or where value was actually added to 

the products. Consequently, corporate groups that produced 

pharmaceuticals, or other products whose final values are largely based on 

the value of intellectual property, were given flexibility under the law to 

shift net income to the possessions corporation operating in Puerto Rico or 

another insular area.

In addition to possessions corporations, U.S. corporate groups often 

owned other types of businesses that operate in Puerto Rico. These 

affiliated businesses could include

• corporations incorporated within the United States but operating in 

Puerto Rico;

• U.S. controlled foreign corporations (CFC), which are incorporated in 

Puerto Rico or elsewhere outside of the United States, but which are 

majority-owned (by vote or value) by one or more U.S. shareholders, 

each of whom owns at least 10 percent of the CFC’s voting stock; or

• a “pass-though entity,” such as a partnership, a subchapter-S 

corporation, or a limited liability company (LLC), which generally does 

not pay federal income tax at the entity level, but whose income passes 

through, and is taxed in the hands of its partners or shareholders.
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Page 7 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Scope and 

Methodology

Federal Tax Treatment To determine the U.S. federal tax treatment of individuals and businesses in 

Puerto Rico, relative to the states and the other insular areas, we examined 

the IRC, Department of the Treasury regulations, relevant Treasury rulings 

and notices, and legislation.

Economic Indicators and 

Capital Flows

To compare trends in principal economic indicators for the United States 

and Puerto Rico, we obtained data from both U.S. and Puerto Rican 

sources. The trends we present are commonly used measures of overall 

economic activity and important components of economic activity, such as 

saving, investment, labor force participation and unemployment. The data 

shown are largely drawn from the National Income and Product Account 

series produced annually by economic statistics agencies in the United 

States and Puerto Rico. Most of the data we used for the U.S. economic 

series are produced by the Bureau of Economic Analysis and the Bureau of 

Labor Statistics. Most of the annual data we used for Puerto Rico economic 

trends are produced by the Planning Board of Puerto Rico. We also used 

data from the Economic Census of Puerto Rico and the Economic Census 

of the United States, produced by the U.S. Census Bureau (Census).

In some instances, the methodologies used by the Planning Board to 

produce certain data series are outdated relative to the methodologies now 

used by the United States. In these cases, we reviewed literature 

concerning the limitations of various series and interviewed Puerto Rican 

officials about the methods they use to collect and develop their data. 

These limitations are noted in the report. Wherever possible, we used 

alternative assumptions and data sources to determine if any conclusions 

drawn from the data are sensitive to the particular data series used. 

To provide information on what is known regarding the flow of capital into 

and out of Puerto Rico, we interviewed Puerto Rican government officials 

and private sector experts to help us to ascertain what data were available. 

We determined that the available data would not allow us to present a 

comprehensive picture of the trends in capital flows. We can, however, 

report on changes between 1995 and 2004 in the amount of funds that 

nonresidents hold in the Puerto Rican banking system and the amount of 
Executive Summary

Page 8 GAO-06-541 Puerto Rican Fiscal and Economic Trends

funds that the banking system invests within and outside of the 

Commonwealth. In order to identify where the assets held in the Puerto 

Rican banking system are invested and where the owners of the banks’ 

liabilities reside, we analyzed institution-specific data that the Office of the 

Commissioner of Financial Institutions (OCFI) collects for oversight 

purposes. We also use data provided by Puerto Rico’s Government 

Development Bank to show trends in Puerto Rican government borrowing 

in the U.S. and local capital markets. 

Changes in Possessions 

Corporation Activity

In order to examine changes in the activities of possessions corporations 

operating in Puerto Rico since the early 1990s, we constructed several 

databases from an assortment of tax return data we obtained from IRS and 

Puerto Rico’s Department of Treasury. Our principal source of data was 

IRS’s Statistics of Income unit (SOI), which compiles comprehensive data 

on possessions corporations every other year. We obtained the complete 

set of these biennial databases from 1993 through 2003 and used 

information from SOI to identify those possessions corporations that 

operated in Puerto Rico. We combined these separate databases into a 

single one that covered 656 possessions corporations that operated in at 

least 1 year between 1993 and 2003 to report on changes over time in the 

aggregate income, tax credit and total assets of this population of 

corporations and to show how these particular variables were distributed 

across different industries. We also used data from the past four Economic 

Censuses of Puerto Rico (1987, 1992, 1997, and 2002) compiled by Census 

to show how the importance of possessions corporations in Puerto Rico's 

manufacturing sector has changed over time.

For the second stage of our analysis, we focused on a subpopulation of the 

largest groups of affiliated possessions corporations operating in Puerto 

Rico. For each of these groups we compiled data on other affiliated 

corporations (i.e., those sharing the same ultimate parent corporations) 

that also operated in Puerto Rico, but were not possessions corporations. 

The objective of this analysis was to assess the extent to which the large 

corporate groups that accounted for most of the activity of possessions 

corporations remained active in Puerto Rico, even as the operations of 

their possessions corporations were being phased out. We started by 

identifying the 77 largest groups of possessions corporations that 

accounted for over 90 percent of the tax credit and income earned and over 

90 percent of the assets owned by possessions corporations between 1993 

and 2003. We then used the database in which IRS maintained the records 

of all CFCs, as well as a database that the Puerto Rican Department of 
Executive Summary

Page 9 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Treasury had recently transcribed from all Puerto Rican tax returns for tax 

years 1998 through 2001 filed by all corporations or partnerships that 

received tax incentives from the Government of Puerto Rico. We linked 

CFCs and other types of companies from these two databases to our 77 

large corporate groups by using identification numbers and names. We 

determined that the quality of the data was sufficient for the purposes of 

our report when viewed with the cautions we raise at various points in the 

text. 

Distribution of Business 

Activity

In order to show how economic activity in Puerto Rico is distributed across 

different forms of businesses, we negotiated a special arrangement with 

IRS and Census that enabled us to disaggregate the data from Census’s 

recently completed 2002 Economic Census of Puerto Rico by categories of 

business entities that are more specifically relevant to tax policymakers 

than the categories Census uses for its own publications. The data that we 

used to determine the tax filing status and place of incorporation for the 

employers in the Census database came from the IRS and Puerto Rico 

databases described above, plus a couple of additional sources. Another 

important source of data was IRS’s National Accounts Profile (NAP) 

database, which contains selected information for all individuals and 

businesses that have federal tax filing requirements. 

Fiscal Comparison To compare the overall taxes paid by individuals and businesses in Puerto 

Rico with the taxes paid by individuals and businesses in the states and in 

the other insular areas, we obtained and analyzed detailed data on state 

and local government revenues from the U.S. Census of Governments, data 

on Commonwealth government revenue from the Puerto Rican Department 

of Treasury, data on municipal tax revenue in Puerto Rico from Oficina del 

Comisionado de Asuntos Municipales, Centro de Estadisticas Municipales, 

and revenue data for the other insular areas reported in their 2002 Single 

Audit reports. We also obtained data on federal taxes collected in Puerto 

Rico and the states from IRS’s 2002 Data Book.11 We compared taxes paid 

on a per capita basis and as a percent of personal income. We make our 

comparison for year 2002 because that is the year of the most recent 

Census of Governments. We also compare federal expenditures for the 

11We did not include the federal corporate tax in our comparison because the location where 

that tax is collected is may not be closely related to where the burden of the tax falls.
Executive Summary

Page 10 GAO-06-541 Puerto Rican Fiscal and Economic Trends

states, Puerto Rico and the insular areas using data we obtained from the 

Consolidated Federal Funds Report for Fiscal Year 2002 and the Federal 

Aid to States for Fiscal Year 2002. 

Federal Social Programs Interviews with federal agencies and prior GAO work provided the basis 

for our description of the application of the principal U.S. federal social 

programs to Puerto Rico residents, relative to the states, and the other 

insular areas. To select the social programs included in this report we 

consulted with GAO experts in the areas of health care policy; education, 

workforce, and income security policy; and financial markets and 

community investment policy. With the help of these experts, we arrived at 

a list of the principal federal social programs, which we then pared down, 

based on program availability in Puerto Rico and expenditure level in 

Puerto Rico. We relied on prior GAO work and interviews with federal 

agency officials to determine how each program is applied in Puerto Rico, 

relative to the other areas. We used program-level data, supplied by federal 

agencies, to report program expenditures for fiscal year 2002. We selected 

fiscal year 2002 because in chapter 6 of this report, we provide a more 

complete analysis of the revenue and expenditures of Puerto Rico, the 

states, and the other insular areas using the year of the most recent Census 

of Governments, 2002. 

Results in Brief Individuals who are residents of Puerto Rico or the other U.S. insular areas 

pay no federal income tax on income from sources within the insular area; 

however, their wages are subject to Social Security and Medicare taxes. 

Wages paid to residents of Puerto Rico and the U.S. Virgin Islands also are 

subject to federal unemployment tax. Corporations organized in Puerto 

Rico, like those organized in the other U.S. insular areas, are generally 

treated as foreign corporations for U.S. tax purposes and do not pay federal 

tax on their income earned in Puerto Rico, but are generally subject to 

federal tax on any income earned in the United States. Corporations 

organized in the United States are subject to federal tax on their worldwide 

income, including that earned in Puerto Rico. U.S. corporations that 

qualified for the possessions tax credit could reduce the federal tax on their 

income from Puerto Rico by using the credit.

The economic well-being of Puerto Rican residents, measured in terms of 

either per capita or median income, remains well below that of residents of 

the states. Puerto Rico’s per capita GNP of about $14,000 in 2005 was 
Executive Summary

Page 11 GAO-06-541 Puerto Rican Fiscal and Economic Trends

significantly below the $41,000 figure for the United States. The latest 

available data show that in 1999, Puerto Rico’s median household income 

of $14,412 also was well below the U.S. median value of $41,994. The 

relative progress that the Puerto Rican economy has made since 1980 is 

difficult to measure with precision for a number of reasons, including the 

fact that the income U.S. corporations have reported earning in the 

Commonwealth may overstate their actual activity there. The low rate of 

labor participation is a crucial issue in Puerto Rico’s economic 

performance, and the rate of investment appears insufficient to 

significantly reduce the disparity between mainland and Puerto Rican 

incomes.

Possessions corporations have played an important role in the Puerto 

Rican economy, particularly in the manufacturing sector, where they 

accounted for well over half of valued added throughout the 1990s. Most of 

the possessions tax credit and income earned by possessions corporations 

in Puerto Rico has been earned by corporations in the pharmaceutical 

industry. Once the possessions tax credit was repealed, many of the large 

corporate groups that owned possessions corporations in Puerto Rico 

began to shift their operations to other types of business entities, such as 

CFCs and LLCs. According to various measures, the decline in activity of 

possessions corporations in the chemical industry, which is dominated by 

pharmaceuticals, has been largely offset by the increased activity of other 

members of the same corporate groups (i.e., who have the same parent 

companies) as the possessions corporations. For example, valued added, 

employment, and capital expenditures in the chemical industry all 

increased between 1997 and 2002—a period during which the activity of 

possessions corporations decreased significantly. Declines in the 

remainder of Puerto Rico’s manufacturing sector have not been similarly 

offset.

U.S.-owned or incorporated businesses accounted for at least 71 percent of 

value added and at least 54 percent of employment in Puerto Rico’s 

manufacturing sector in 2002. CFCs produced most of this value added but 

possessions corporations still accounted for most of the employment by 

U.S. firms. The CFCs are particularly important in the pharmaceutical 

industry and much less so in other manufacturing industries. U.S.-owned or 

incorporated businesses appear to account for less than 25 percent of 

employment in Puerto Rico’s wholesale and retail trade sectors, where 

local corporations are the most important employers. Similarly, U.S.-owned 

corporations are not the majority employers in any of the large Puerto 

Rican service industries for which data are available.
Executive Summary

Page 12 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Residents of Puerto Rico pay considerably less total tax per capita than do 

U.S. residents, but they pay about the same percentage of their personal 

income in taxes. The average burden of federal taxes (excluding the 

corporate income tax) in Puerto Rico was considerably lower than that in 

the states, but the difference was made up by the fact that Commonwealth 

and local taxes in Puerto Rico were higher than the average state and local 

taxes. Federal grants and payments to the Puerto Rican government in 2002 

were about the same as those to all state and local governments in the 

states on a per capita basis; however, direct federal payments to individuals 

in Puerto Rico were well below the per capita amounts paid to residents in 

the states. Similarly, per capita federal payments for salaries and wages and 

for procurement were significantly lower in Puerto Rico than in the states.

Like the states, Puerto Rico and the other insular areas receive federal 

funds for a variety of social programs, which provide assistance to the 

elderly and low-income families and individuals. The social programs that 

we examined in the insular areas targeted similar populations and 

delivered similar services to those in the states—although sometimes the 

program had different rules and funding than in the states. 

Principal Findings 

U.S. Federal Tax Treatment 

of Puerto Rico and Other 

Insular Areas Differs by 

Area and Type of Tax

Individuals who are residents of Puerto Rico or the other U.S. insular areas 

pay no federal income tax on income from sources within the insular area. 

The federal tax treatment of U.S.-source income earned by these 

individuals varies by insular area. Federal Insurance Contributions Act 

(FICA) taxes are imposed on wages paid to residents of all of the U.S. 

insular areas, but the unemployment insurance tax applies only to wages 

paid to residents of Puerto Rico and the U.S. Virgin Islands. 

Corporations created or organized in the United States or under the laws of 

the United States or of a state are taxed by the federal government on their 

worldwide income, including that earned in Puerto Rico and the other 

insular areas. U.S. corporations may be able, however, to reduce their U.S. 

tax liability on their foreign source income by way of a credit against their 

U.S. tax for foreign income taxes paid. Additionally, while income from a 

foreign business operation that is not organized as a separate legal entity is 

taxed currently, income from the active conduct of business operations set 

up by U.S. shareholders as separate corporations organized under the laws 
Executive Summary

Page 13 GAO-06-541 Puerto Rican Fiscal and Economic Trends

of a foreign country generally is not taxed to the U.S. shareholders until it is 

repatriated as dividends. Although, if the income from the foreign 

corporation is connected to business that the foreign corporation has in the 

U.S., the income is taxed currently to the foreign corporation.

Corporations organized in Puerto Rico, like those organized in the other 

insular areas, are generally treated for U.S. tax purposes as if they were 

organized under the laws of a foreign country. Until this year, a possessions 

tax credit enabled corporations organized in the United States that met 

certain conditions to reduce the federal tax payable on income earned in 

and repatriated from Puerto Rico and other insular areas. The credit had 

been designed to encourage U.S.-based corporations to invest in these 

areas. 

Federal customs duties apply to foreign goods imported into Puerto Rico, 

and federal excise taxes apply to selected goods manufactured in Puerto 

Rico and exported to the United States, but the revenues from these taxes 

and duties are given to the Puerto Rican Treasury.

Measuring Economic 

Progress in Puerto Rico Is 

Challenging, but the Income 

of Commonwealth 

Residents Remains Well 

Below That of U.S. 

Residents

As shown in figure 1, Puerto Rico’s per capita GDP of about $21,000 in 2005 

remained well below U.S. per capita GDP of about $41,000. According to 

the Puerto Rican and U.S. national income and product accounts, this 

measure has grown more rapidly in Puerto Rico than in the United States 

since 1980, when viewed on a per capita basis after adjustments for 

inflation. However, for a number of reasons, the growth rate of real 

(meaning inflation-adjusted) GDP likely does not represent a very accurate 

measure of changes in the economic well-being of Puerto Rican residents. 

One important reason is that a significant amount of the investment income 

included in GDP is paid out to U.S. and foreign investors. Per capita GNP 

and median household income are better measures of the income earned 

by residents. Puerto Rico’s per capita GNP of about $14,000 in 2005 was 

significantly below the $41,000 figure for the United States. The latest 

available data show that in 1999, Puerto Rico’s median household income 

of $14,412 also was well below the U.S. median value of $41,994. Puerto 

Rican government officials acknowledged significant concerns regarding 

the accuracy of their official implicit price deflator (a measure of price 

changes), due to the age of the underlying methodology.12 (There are plans 

12In the report all references to the Puerto Rican deflator refer to the Puerto Rican implicit 

gross product deflator.
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Page 14 GAO-06-541 Puerto Rican Fiscal and Economic Trends

to overhaul this methodology with the assistance of the U.S. Bureau of 

Economic Analysis.) The likelihood of inaccuracy in the existing deflator 

makes it difficult to say precisely how fast Puerto Rican incomes have 

grown in real (inflation-adjusted) terms. The U.S. price deflator is an 

alternative for converting the Puerto Rican data into real terms; however, 

since that deflator is designed to measure price changes in the U.S. 

economy, it is not clear how well it reflects changes in Puerto Rican prices. 

Using the amounts shown in figure 1, inflation-adjusted per capita GNP 

increased at an average annual rate of 1.9 percent in the United States, 

while it rose at 1.5 percent in Puerto Rico if the Puerto Rican deflator is 

used. However, if the U.S. deflator is applied to Puerto Rican GNP, annual 

real per capita GNP rose by 2.5 percent annually, faster than the growth in 

the United States. 

Figure 1: U.S. and Puerto Rican Real Per Capita GDP and GNP, 1980–2005

Note: Figures were adjusted for inflation using U.S. and Puerto Rican gross product deflators. 

Dollars (constant 2005)

Source: GAO analysis of U.S. Bureau of Economic Analysis and Puerto Rican Planning Board data.

Fiscal year

U.S. GNP per capita

U.S. GDP per capita

Puerto Rican GDP per capita (Puerto Rican deflator)

Puerto Rican GDP per capita (U.S. deflator)

Puerto Rican GNP per capita (Puerto Rican deflator)

Puerto Rican GNP per capita (U.S. deflator)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Executive Summary

Page 15 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The other problems with using the trend in per capita GDP as a measure of 

Puerto Rico’s economic progress are that (1) federal tax rules have given 

U.S.-owned corporations an incentive to overstate the amount of income 

they earn in Puerto Rico and those rules changed during the 1990s in a way 

that may have affected the extent of the overstatement, and (2) the scale of 

the informal, or underground, economy in Puerto Rico relative to the 

informal economy in the United States is unknown. The first of these 

problems results in an overstatement of Puerto Rico’s GDP, but not its GNP. 

If the size and growth in the informal economy in Puerto Rico is large 

relative to the size and growth of informal economy in the United States, 

comparisons between levels and growth in both per capita GDP and GNP in 

the two jurisdictions could be affected.

Overall, employment in Puerto Rico has grown over the past two decades, 

despite a decline in manufacturing jobs. The gap in the rate of 

unemployment between Puerto Rico and the United States has narrowed in 

recent years, but Puerto Rico’s rate of 10.6 percent in 2005 was still notably 

higher than the rate in the United States, which was below 6 percent. 

Puerto Rico’s labor participation has been under 50 percent throughout the 

past two decades, well below the U.S. rate, which has generally been above 

65 percent. This low labor participation rate in Puerto Rico, along with a 

relatively low rate of investment there, despite considerable investment 

from nonresidents, are two key issues that affect Puerto Rico’s economic 

performance.

Some Measures of 

Aggregate Manufacturing 

Activity Have Remained 

Constant Despite a Decline 

in Possessions Corporation 

Activity

U.S. corporations claiming a possessions tax credit played a dominant role 

in Puerto Rico’s manufacturing sector into the late 1990s. According to the 

economic censuses of the Puerto Rican manufacturing sector that Census 

compiles every five years, possessions corporations accounted for 38.2 

percent of employment and 61.6 percent of output in the manufacturing 

sector in 1987. These shares rose to 40.8 percent and 72.0 percent in 1997, 

before falling to 31.8 percent and 26.7 percent by 2002. Tax data show that 

the amount of possessions tax credit that these corporations claimed 

peaked at $5.8 billion in 1993, the last year before the generosity of the 

credit was significantly curtailed, and that the gross profits of these 

corporations earned in Puerto Rico peaked at $28.8 billion in 1997, the year 

after the possessions tax credit was repealed (starting a 10-year phaseout 

period).

From 1993 to 2003, the number of corporations claiming the credit for 

operations in Puerto Rico fell from 378 to 124, and the amount of credit 
Executive Summary

Page 16 GAO-06-541 Puerto Rican Fiscal and Economic Trends

claimed declined from $5.8 billion to $1.1 billion. The gross profits that 

these corporations earned in Puerto Rico dropped from $24.8 billion to 

$12.1 billion, and their total assets declined from $59.5 billion to $41.1 

billion.

A combination of tax return and Economic Census data indicate that the 

decline in income and value added of possessions corporations has been 

largely offset by an increase in the income and value added of affiliated 

corporations that left aggregate income and value added roughly the same. 

GAO tracked the best available data on the affiliated corporate groups that 

have claimed almost all of the possessions tax credit since 1993 and found 

that the decline in the reported gross profits, total income, and total assets 

of possessions corporations within those groups was largely offset by 

increases in the reported gross profits and assets of affiliated corporations 

operating in Puerto Rico between 1997 and 2001, particularly those 

incorporated outside of the United States. Data from recent Economic 

Censuses of Puerto Rico, presented in figure 2, show that the decline in 

value added by possessions corporations in the chemical industry (which is 

dominated by pharmaceuticals) between 1997 and 2002 was more than 

offset by increases in the value added of other types of businesses. In 

contrast, value added for both possessions corporations and all other types 

of businesses declined in the remainder of the manufacturing sector over 

that period. A change in Census’s industrial classification system between 

1997 and 2002 means that the scope of the industries being compared for 

those two years in the following figures may not be exactly the same.13

However, the basic point of each of these figures is not invalidated by this 

factor.

Although some evidence of a possible change in income-shifting behavior 

by U.S.-owned businesses makes it difficult to say how accurately trends in 

reported income and value-added data represent trends in actual economic 

activity in Puerto Rico, data on capital expenditures (fig. 3), employment 

(fig. 4), and total assets (none of which should be distorted by income 

shifting) support the conclusion that a substantial amount of possessions 

corporation activity has been continued by other types of businesses. 

However, most of this continued activity is concentrated in the 

pharmaceutical industry and the decline in possessions corporation 

13Census used the Standard Industrial Classification (SIC) up until the 1997 Census and used 

the North American Industrial Classification System (NAICS) for the 2002 Census. This 

change should not affect the basic message of any of the figures in this report.
Executive Summary

Page 17 GAO-06-541 Puerto Rican Fiscal and Economic Trends

activity in the remainder of Puerto Rico’s manufacturing sector has not 

been offset. None of the data GAO presents addresses the question of what 

corporate activity would have taken place during this period if the 

possessions tax credit had not been repealed.

Figure 2: Value Added for Possessions Corporations and Other Types of Employers

in the Chemical Industry and All Other Manufacturing Industries, 1997–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Constant 2005 dollars in billions

Industry and year

All other types of businesses

Possessions corporations

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the

2002 Economic Census of Island Areas provided by the U.S. Census Bureau.

0

5

10

15

20

25

30

35

40

All other

industries

2002

All other

industries

1997

Chemicals

2002

Chemicals

1997

Industry classifications

changed from SIC to NAICS
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Page 18 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 3: Capital Expenditures in Puerto Rico’s Manufacturing Sector, by Industry, 

1987–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Constant 2005 dollars in billions

Years

All other manufacturing

Pharmaceuticals

Source: GAO analysis of published data from the 2002 Economic Census of Island Areas and the

Economic Census of Outlying Areas for 1987,1992, and 1997.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
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Page 19 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 4: Employment in Possessions Corporations and Other Types of Employers

in the Chemical Industry and All Other Manufacturing Industries, 1997–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

U.S.-owned or U.S.-

incorporated Businesses 

Dominated Puerto Rican 

Manufacturing in 2002 but 

Played Much Smaller Roles 

in Other Sectors of the 

Economy

U.S.-owned businesses accounted for at least 71 percent of value added and 

at least 54 percent of employment in Puerto Rico’s manufacturing sector in 

2002. CFCs produced most of this value added but possessions 

corporations still accounted for most of the employment by U.S. firms. The 

CFCs are particularly important in the pharmaceutical industry and much 

less so in other manufacturing industries. U.S. corporations appear to 

account for less than 25 percent of employment in Puerto Rico’s wholesale 

and retail trade sectors, where local corporations are the most important 

employers. Similarly, U.S.-owned corporations are not the majority 

employers in any of the large Puerto Rican service industries for which 

data are available.

Number of employees

Industry and year

All other types of businesses

Possessions corporations

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

All other

industries

2002

All other

industries

1997

Chemicals

2002

Chemicals

1997

Industry classifications

changed from SIC to NAICS

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the 2002

Economic Census of Island Areas provided by the U.S. Census Bureau.
Executive Summary

Page 20 GAO-06-541 Puerto Rican Fiscal and Economic Trends

As of 2002, U.S. CFCs accounted for 42 percent of value added in Puerto 

Rico’s manufacturing sector—a larger share than that of any other type of 

business entity (see fig. 5). They were able to produce this value added with 

a relatively small share—14 percent—of the sector’s total employment (see 

fig. 6). Possessions corporations, which had the next largest share of value 

added, with 27 percent, remained the largest single type of employer, with 

31 percent of the sector’s employment.

Figure 5: Distribution of Value Added for All Puerto Rican Manufacturing by Type of 

Business Entity, 2002

Note: Value-added figures for sole proprietors round to 0 percent.

5%

2%

7%

8%

9%

27% 15%

27%

CFCs incorporated

outside of Puerto Rico

CFCs incorporated

in Puerto Rico

All other employers

Pass-through

entities

0%

Sole proprietors

Other U.S. corporations

Possessions corporations

Other corporations

incorporated in

Puerto Rico

Corporations of

type unknown

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Executive Summary

Page 21 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 6: Distribution of Employment for All Puerto Rican Manufacturing by Type of 

Business Entity, 2002

Taxes Paid Per Capita in 

Puerto Rico Are 

Considerably Lower Than 

Those in the States but the 

Taxes are About the Same 

Share of Personal Income in 

Both Places 

The per capita tax burden imposed by all levels of government (federal, 

Commonwealth, and local) in Puerto Rico in 2002 was $3,071, considerably 

less than the per capita burden of $9,426 in the states (see fig. 7). However, 

the combined tax burden in Puerto Rico amounted to 28 percent of 

personal income, which was close to the 30 percent burden in the states 

(see fig. 8).14 The rate for the five states with the highest combined tax 

burden was 39 percent, while that for the five states with the lowest burden

2%

3%

7%

6%

7%

9%

12%

31%

23%

CFCs incorporated

outside of Puerto Rico

CFCs incorporated

in Puerto Rico

All other employers

Pass-through

entities

Sole proprietors

Other U.S. corporations

Possessions corporations

Other corporations

incorporated in

Puerto Rico

Corporations of

type unknown

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.

14Data on personal income and on federal taxes paid in the other insular areas are not 

available. Taxes paid by residents of the other insular areas to their own governments in 

2002 amounted to $2,451 per capita—slightly higher than the $2,310 per capita that residents 

of Puerto Rico paid to the Commonwealth and municipal governments.
Executive Summary

Page 22 GAO-06-541 Puerto Rican Fiscal and Economic Trends

was 23 percent.15 The average burden of federal taxes (excluding the 

corporate income tax, which is difficult to allocate by location) in Puerto 

Rico was considerably lower than in the states, but this difference was 

made up by the fact that Commonwealth and local taxes in Puerto Rico 

were higher than the average state and local taxes. Commonwealth income 

and sales taxes were higher as a percent of personal income than those of 

state and local governments, but property taxes in the Commonwealth 

were lower. 

Figure 7: Per Capita Taxes Paid in the United States and Insular Areas, Fiscal Year 

2002

15The five states with the highest combined tax burden were the District of Columbia, 

Minnesota, Delaware, Connecticut, and New Jersey. Those with the lowest were Montana, 

South Carolina, Alabama, West Virginia, and Mississippi.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Other insular

areas

Average for

low five

states

Average for

high five

states

Puerto Rico States

Dollars per capita

Jurisdictions

Federal taxes

Commonwealth, state, and local taxes

Source: GAO analysis of IRS, Census, and Insular Area Treasury Department data.
Executive Summary

Page 23 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Federal grants and payments to the Puerto Rican government in 2002 

amounted to $1,242 per capita, about the same as the $1,264 per capita paid 

to all state and local governments in the states, but less than the $1,703 per 

capita paid to the other insular area governments. The $2,057 per capita of 

direct federal payments to individuals in Puerto Rico was well below the 

$3,648 per capita paid to state residents, but higher than the $1,418 per 

capita paid to residents of the other insular areas. The per capita federal 

payments of $336 for salaries, wages, and procurement in Puerto Rico were 

about 20 percent of payments for those purposes in the states and the other 

insular areas.

Figure 8: Taxes Paid as a Share of Personal Income in the United States and Insular 

Areas, Fiscal Year 2002

0

5

10

15

20

25

30

35

40

Average for

low five

states

Average for

high five

states

Puerto Rico States

Percentage

Jurisdictions

Federal taxes

Commonwealth, state, and local taxes

Source: GAO analysis of IRS, Census, and Insular Area Treasury Department data.
Executive Summary

Page 24 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The Extent to Which 

Federal Social Programs in 

Puerto Rico Mirror Those in 

the States and U.S. Insular 

Areas Varies

The social programs that we examined in the insular areas generally 

targeted similar populations and delivered similar services to those in the 

states—although sometimes the program had different rules and funding 

than in the states. For example, in lieu of the Food Stamp Program 

available in the states, which is an entitlement program based on the 

number of participants, Puerto Rico receives a capped block grant that has 

similar eligibility requirements. The major difference between some of the 

social programs GAO examined in the states versus those in Puerto Rico 

and the other insular areas is how they are funded. For example, under 

HOME Investment Partnerships eligibility rules are the same in Puerto Rico 

and the states; however, unlike for the states, the amount of HOME funding 

is subject to a cap. To cite another example, where federal Medicaid 

spending is an open-ended entitlement to the states, it is subject to a 

statutory cap and a limited matching rate in Puerto Rico and the other 

insular areas. Some of the social programs that GAO examined are 

available in the states, but not in some of the insular areas. Table 1 

summarizes how selected social programs compare between Puerto Rico 

and the states.

Table 1: Summary of Selected Social Programs in Puerto Rico Compared to Those 

in the States

Same in Puerto Rico and the 

states

Operates the same in Puerto 

Rico, or comparable 

programs operate, but 

financing differs

Some components

have financing 

differences and 

some do not

Individuals with Disabilities 

Education Act (IDEA) Part B

Food Stamp or Nutrition 

Programs

Health Grants

Title I of the Elementary and 

Secondary Education Act, 

reauthorized by the No Child Left 

Behind Act of 2001

Medicare

Child and Adult Care Food 

Program

Medicaid

National School Lunch Program State Children’s Health 

Insurance Program (SCHIP)

Special Supplemental Nutrition 

Program for Women, Infants, and 

Children (WIC)

Aid to the Aged, Blind, or 

Disabled (AABD)

HOPE VI Temporary Assistance for 

Needy Families (TANF)
Executive Summary

Page 25 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Source: GAO analysis of U.S. federal social programs.

Agency Comments GAO shared a draft of this report with representatives of the Governor of 

Puerto Rico. In written comments the Governor said that he is confident 

the report will be useful to Congress for evaluating options for promoting 

jobs and investment in Puerto Rico. The Governor highlights the 

disproportionate job loss in Puerto Rican manufacturing over the last 10 

years and notes, as the report states, that the report does not attempt to 

project what the current level of manufacturing employment and value 

added would have been had the credit not been repealed. The Governor’s 

letter is reprinted in appendix IX.

Housing Choice Vouchers Child Care and Development 

Fund (CCDF)

Community Development Block 

Grants 

Foster Care and Adoption 

Assistance

Project-based Section 8 HOME Investment 

Partnerships

Public Housing

Section 203 (b) Single Family 

Mortgage Insurance Program

(Continued From Previous Page)

Same in Puerto Rico and the 

states

Operates the same in Puerto 

Rico, or comparable 

programs operate, but 

financing differs

Some components

have financing 

differences and 

some do not
Page 26 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 1

Introduction Chapte1r

The federal and Commonwealth governments have had a long-term interest 

in policies to stimulate economic growth in Puerto Rico. Historically, the 

centerpiece of these policies has been the combination of the possessions 

tax credit in the U.S. Internal Revenue Code (IRC) and extensive tax 

incentives in the Puerto Rican tax code for U.S. and foreign businesses. In 

the early 1990s Congress became dissatisfied with the effectiveness of the 

credit and introduced restrictions to better target employment-generating 

activities. Then in 1996 Congress repealed the credit but allowed existing 

possessions corporations to earn either the possessions credit or a 

replacement credit during a 10-year phaseout period ending in 2006. 

Various proposals have been placed before Congress for some form of 

replacement assistance to the Puerto Rican economy. Congress could 

better assess the merits of the various proposals if it had more complete 

information relating to the recent performance of the Puerto Rican 

economy, the current treatment that Commonwealth residents receive 

under both federal tax policies and federal social programs, and 

information relating to the burden of taxes that residents of Puerto Rico 

pay, relative to those paid by residents of the states and the other U.S. 

insular areas.

To provide a basis for future decisions regarding legislation on Puerto 

Rican economic issues, this report

• explains how the U.S. federal tax treatment of individuals and 

businesses in Puerto Rico and of the insular government differs relative 

to the treatment of governments, businesses, and individuals in the 

states and the other U.S. insular areas;

• compares trends in Puerto Rico’s principal economic indicators since 

the early 1980s with similar indicators at the national level for the 

United States and provides what is known about capital flows between 

Puerto Rico and the United States and between Puerto Rico and foreign 

countries;

• reports on changes in the activities and tax status of the corporations 

that have claimed the possessions tax credit since 1993;

• provides information on the distribution of private-sector economic 

activity in Puerto Rico by type of business entity;
Chapter 1

Introduction

Page 27 GAO-06-541 Puerto Rican Fiscal and Economic Trends

• describes the total amount of tax paid by individuals and businesses in 

the states and the U.S. insular areas and shows percentage breakdowns 

by type of tax; and

• describes how the principal U.S. federal social programs apply to Puerto 

Rican residents, relative to residents of the states and the other U.S. 

insular areas.

Background Puerto Rico is one of the two nonstate Commonwealths associated with 

the United States. The other is the Commonwealth of the Northern Mariana 

Islands (CNMI). The United States also has three major territories under 

the jurisdiction of the U.S. Department of Interior. The major territories are 

Guam, the U.S. Virgin Islands, and American Samoa. The three major 

territories plus the two nonstate Commonwealths are referred to in this 

report as “the insular areas.”1

 These areas are often grouped together in this 

manner for the purpose of federal legislation. For this reason, and when 

necessary for the purpose of comparison to Puerto Rico, this report 

provides a limited discussion on the other insular areas.

With the exception of American Samoa, those born in the insular areas are 

U.S. citizens; however, insular area residents are not afforded all of the 

rights of citizens residing in the states.2

 More than four million U.S. citizens 

and nationals live in the insular areas. These areas vary in terms of how 

they came under the sovereignty of the United States and also in terms of 

their demographics, such as median age and education levels. Each of the 

insular areas has its own government and maintains a unique diplomatic 

relationship with the United States. General federal administrative 

responsibility for all insular areas but Puerto Rico is vested in the 

Department of the Interior. All departments, agencies, and officials of the 

executive branch treat Puerto Rico administratively “as if it were a state”; 

1

These five insular areas are the subject of this report. The nine smaller U.S. territories that 

are not included in our report’s definition of insular areas, because they are not included in 

the scope of this report, are Navassa Island in the Caribbean Sea, and Baker Island, 

Howland Island, Kingman Reef, Jarvis Island, Johnston Atoll, Midway Atoll, Palmyra Atoll, 

and Wake Island in the Pacific Ocean. 

2

A person born in American Samoa is considered to be a national of the United States who 

although not a citizen owes permanent allegiance to the United States. 8 U.S.C. § 

1101(a)(21), (22) (2000). While U.S. nationals are not entitled to all the benefits for which 

only citizens qualify they are not aliens and therefore cannot be expelled or deported.
Chapter 1

Introduction

Page 28 GAO-06-541 Puerto Rican Fiscal and Economic Trends

any matters concerning the fundamentals of the U.S.-Puerto Rican 

relationship are referred to the Office of the President.3

Residents of all the insular areas enjoy many of the rights enjoyed by U.S. 

citizens in the states. But some rights that, under the Constitution, are 

reserved for citizens residing in the states have not been extended to 

residents of the insular areas. For example, residents of the insular areas 

cannot vote in national elections, nor do their representatives have full 

voting rights in Congress. Residents of all of the insular areas receive 

federally funded aid for a variety of social programs. Although residents of 

an insular area do not pay federal income taxes on income earned in that 

insular area, federal tax policy does play an important role in the 

economies of the insular areas.4

 Historically, the federal government has 

used tax policy as a tool to encourage investment and increase employment 

in the insular areas.

Puerto Rico’s Relationship 

with the United States

Puerto Rico’s Constitution of 1952 defines Puerto Rico as a self-governing 

Commonwealth of the United States.5

 Although fiscally autonomous, 

Puerto Rico is similar to the states in many aspects. For example, matters 

of currency, interstate commerce, and defense are all within the 

jurisdiction of the U.S. federal government. Puerto Rican residents are 

required to pay local income taxes on income earned from Puerto Rican 

sources, but not federal income taxes. Puerto Rican residents, however, do 

contribute to the U.S. national Medicare and Social Security systems. 

Generally, federal labor, safety, minimum wage laws and standards also 

apply in Puerto Rican to the same extent they apply to the states. The 

federal government plays a pervasive role in Puerto Rico that stems not 

only from the applicability of the United States Constitution, laws and 

regulations, but from the transfer to the island of more than $13 billion in 

federal funds every year to fund social programs to aid Puerto Rican 

residents, including earned benefits such as Social Security and 

unemployment benefits.

3

Memorandum of the President, 57 Fed. Reg. 57, 093 (Nov. 30, 1992). 

4

Residents pay local income taxes while contributing to the U.S. national Medicare and 

Social Security systems. 

5

L.P.R.A. Const. Art. I § 1 (2004).
Chapter 1

Introduction

Page 29 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapters 2 and 7 of this report discuss in detail the how the U.S. federal tax 

code applies to residents of Puerto Rico and how the principal U.S. federal 

social programs are applied in Puerto Rico, respectively.

Characteristics of Puerto 

Rico

Puerto Rico occupies a central position in the West Indies. It comprises six 

main islands with a land area of 3,421 square miles and a population of 

almost four million people. Puerto Rico is thought to have one of the most 

dynamic economies in the Caribbean region, an economy in which 

manufacturing, driven by the pharmaceutical industry, has surpassed 

agriculture as the primary sector in terms of domestic income. Over 40 

percent of Puerto Rico’s domestic income since the mid-1980s has been 

derived from manufacturing. Pharmaceuticals accounted for almost 40 

percent of total value added in manufacturing in 1987; that share rose to 

over 70 percent by 2002. Table 2 describes some of the demographic 

characteristics of Puerto Rico and compares them to national averages in 

2000.

Table 2: Demographic Characteristics of Puerto Rico Compared to the United States

Source: 2000 Census of the United States.

Possessions Tax Credit Historically, income derived from operations of U.S. corporations in U.S. 

possessions has been subject to special tax provisions. The Tax Reform Act 

of 1976 modified the form of the preferential tax treatment by establishing 

the possessions tax credit under Section 936 of the Internal Revenue Code. 

The stated purpose of this tax credit was to “assist the U.S. possessions in 

Characteristics Puerto Rico The 50 states

Population 3,808,610 281,421,906

Median age 32.1 35.3

Percent under 19 years of age 32.0 27.1

Percent over 65 years of age 11.2 12.4

Infant mortality per 1,000 live births 9.4 6.9

Percent high school graduate or more (over age 

25) 60.0 80.4

Percent bachelor’s degree or more (over age 25) 18.3 24.4

Estimated median household income $14,412 $41,994

Percentage of individuals below poverty level 48.2 12.4
Chapter 1

Introduction

Page 30 GAO-06-541 Puerto Rican Fiscal and Economic Trends

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

to 1994, the possessions 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 possession income.

The possessions tax credit was criticized on the grounds that the 

associated revenue cost was high compared to the employment it 

generated, that a large share of the benefits of the credit were not reaped 

by Puerto Rican residents and that it distorted debate over Puerto Rico’s 

political status. The Omnibus Budget Reconciliation Act of 1993 placed 

caps on the amounts of possessions credits that corporations could earn 

for tax years beginning in 1994 or later.6

 The Small Business Job Protection 

Act of 1996 repealed the possessions tax credit for taxable years beginning 

after 1995.7

 However, the act provided transition rules under which a 

corporation that was an existing credit claimant was eligible to claim 

credits with respect to possessions business income for a period lasting 

through taxable years beginning before 2006. Additional background on 

Section 936 of the U.S. Tax Code and the possessions credit is provided in 

chapters 2 and 4.

6

Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66 (1993).

7

Small Business Job Protection Act of 1996, Pub. L. No. 104-188 (1996).
Chapter 1

Introduction

Page 31 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Additional Studies Relating 

to the Economy of Puerto 

Rico

Several of our previous studies, as well as work done by the Internal 

Revenue Service (IRS) and the U.S. Census Bureau (Census), address 

aspects of the Puerto Rican economy discussed in this report, including the 

business activity of possessions corporations and employment, payroll, 

value added, and capital expenditures by economic sector. Our previous 

work also addresses broader trends in the Puerto Rican economy, as does 

work underway by the Brookings Institution. A related study is also 

expected shortly by the Joint Committee on Taxation. Its work will 

evaluate legislative options concerning Puerto Rico. Table 3 highlights the 

scope of several recent reports on Puerto Rico, as well as the two studies 

that are in progress.
Chapter 1

Introduction

Page 32 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 3: Recent and Forthcoming Reports on Puerto Rico

Source: GAO.

a

Randy Miller, “U.S. Possessions Corporations, 1995,” SOI Bulletin, IRS; Sarah Nutter, “U.S. 

Possessions Corporations Returns, 1997 and 1999,” SOI Bulletin, IRS; Daniel Holik, “U.S. 

Possessions Corporations Returns, 2001,” SOI Bulletin, IRS. 

b

Susan M. Collins, Barry P. Bosworth, and Miguel Soto-Class, eds.,The Economy of Puerto Rico: 

Restoring Growth, (Washington, D.C.: The Brookings Institution, 2006).

Scope and 

Methodology

The Chairman and Ranking Minority Member of the U.S. Senate Committee 

on Finance asked us to study fiscal relations between the federal 

government and Puerto Rico and trends in the Commonwealth’s economy 

with a particular focus on the activities of possessions corporations 

operating there.

Report Scope

GAO, Puerto Rico and the Section 936 Tax Credit, GAO/GGD-93-

109 (Washington, D.C.: June 8, 1993)

This report presented information relevant to Congress’s 

consideration of proposals to revise Section 936 of the IRC. 

GAO, Tax Policy: Puerto Rican Economic Trends, GAO/GGD-97-

101 (Washington, D.C.: May 14, 1997)

This report provided information on economic activity in Puerto Rico, 

before and after the changes in U.S. tax benefits, under Section 936 

of the IRC. 

GAO, U.S. Insular Areas: Multiple Factors Affect Federal Health 

Care Funding, GAO-06-75 (Washington, D.C.: Oct. 14, 2005)

This report identified the key sources of federal health care funding in 

the insular areas, the differences between insular areas and the 

states in the methods used to allocate these funds, and the 

differences in spending levels per individual between the insular 

areas and the states.

IRS research on possessions corporations, published by Statistics 

of Income, in odd yearsa

In odd years, from 1993 to 2001, IRS’s Statistics of Income division 

studied corporations claiming the possessions tax credit in Puerto 

Rico. 

Census’s 1992, 1997, and 2002 Economic Census of Island 

Areas

The censuses include information on employment, payroll, value 

added, and capital expenditures by economic sector.

Brookings Institution’s report on restoring growth in Puerto Ricob Economists from the United States and Puerto Rico address a range 

of major policy issues affecting the island’s economic development 

and propose a strategy for jumpstarting Puerto Rican economic 

growth. The book includes Puerto Rico’s past experience with growth 

policies, and an analysis of several reforms and new initiatives in 

labor, education, entrepreneurship, fiscal policy, migration, trade, and 

financing development. 

Forthcoming study by the Joint Committee on Taxation This study will analyze the tax and economic policy implications of 

legislative options concerning Puerto Rico. In particular it will 

examine the revenue costs of these options and compare the options 

to current laws relative to the states and the other U.S. insular areas.
Chapter 1

Introduction

Page 33 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Federal Tax Treatment To determine the U.S. federal tax treatment of individuals and businesses in 

Puerto Rico, relative to the states and the other insular areas, we examined 

the IRC, Department of the Treasury regulations, relevant Treasury rulings 

and notices, and legislation.

Economic Indicators and 

Capital Flows

To compare trends in principal economic indicators for the United States 

and Puerto Rico, we obtained data from both U.S. and Puerto Rican 

sources. The trends we present are commonly used measures of overall 

economic activity and important components of economic activity, such as 

saving, investment, labor force participation, and unemployment. We 

reported on many of these indicators in our previous report on economic 

trends in Puerto Rico.8

 The data shown are largely drawn from the National 

Income and Product Account series produced annually by economic 

statistics agencies in the United States and Puerto Rico. Most of the data 

we used for the U.S. economic series are produced by the Bureau of 

Economic Analysis and the Bureau of Labor Statistics and are publicly 

available from the Internet. When we compared U.S. data to Puerto Rican 

data that are based on the Puerto Rican July 1–June 30 fiscal year, we 

computed annual U.S. figures using monthly or quarterly data to match the 

Puerto Rican fiscal year.

Most of the annual data we used for Puerto Rican economic trends are 

produced by the Planning Board of Puerto Rico and are also publicly 

available. In some instances, the methodologies used by the Planning 

Board to produce certain data series are outdated relative to the 

methodologies now used by the United States. For example, the 

methodology used in calculating certain price indices in Puerto Rico is 

outdated and the methods used to obtain unemployment data have been 

somewhat less rigorous than in the United States. In these cases, we 

reviewed literature concerning the limitations of various series and 

interviewed Puerto Rican officials about the methods they use to collect 

and develop their data. These limitations are noted in the report. Wherever 

possible, we used alternative assumptions and data sources to determine if 

any conclusions drawn from the data are sensitive to the particular data 

series used. For example, we applied both U.S. and Puerto Rican price 

indices to Puerto Rican gross domestic product (GDP) data to see if 

8

GAO, Tax Policy: Puerto Rican Economic Trends, GAO/GGD-97-101 (Washington, D.C.: 

May 14, 1997).
Chapter 1

Introduction

Page 34 GAO-06-541 Puerto Rican Fiscal and Economic Trends

applying different measures of price changes would lead to different 

conclusions about whether the Puerto Rican economy has been growing 

faster or slower than the U.S. economy. Puerto Rico’s Planning Board has 

recently contracted with several consultants for a review of their entire set 

of methodologies for preparing the Commonwealth’s income and product 

accounts, including the deflators. The Board has also been negotiating a 

memorandum of agreement with the U.S. Bureau of Economic Analysis for 

the latter to provide advice on this effort.

For some indicators of interest, annual data are not available for Puerto 

Rico. In some of these cases, we used decennial census data. The decennial 

census covers both the United States and Puerto Rico and produces 

comparable statistics on educational attainment and poverty levels. We 

also used data from the Economic Census of Puerto Rico and the 

Economic Census of the United States, also produced by Census. These 

data included detailed information on employment, investment, and value 

added broken down by sector of the economy. These data, produced by 

Census every 5th year, are of particular relevance to the possible effects of 

phaseout of the possessions tax credit.

To provide information on what is known regarding the flow of capital into 

and out of Puerto Rico, we interviewed Puerto Rican government officials 

and private sector experts to help us to ascertain what data were available. 

We determined that the available data would not allow us to present a 

comprehensive picture of the trends in capital flows. The most significant 

gap in that picture is data relating to direct investment by corporations 

incorporated outside of Puerto Rico, which is financed from within their 

own affiliated groups, rather than through financial institutions.9

 We can, 

however, report on changes over the years between 1995 and 2004 in the 

amount of funds that nonresidents hold in the Puerto Rican banking system 

and the amount of funds that the banking system invests within and outside 

of the Commonwealth. In order to identify where the assets held in the 

Puerto Rican banking system are invested and where the owners of the 

banks’ liabilities reside, we analyzed institution-specific data that the Office 

of the Commissioner of Financial Institutions (OCFI) collects for oversight 

purposes. Banks and certain other financial institutions in Puerto Rico are 

9

Foreign direct investment is the investment of foreign assets directly into domestic 

structures, equipment, and organizations. It does not include foreign investment into stock 

markets. For Puerto Rico, foreign assets are United States assets as well as assets from 

foreign countries. In Puerto Rico, for the purpose of calculating foreign direct investment, a 

domestic company is a company incorporated in Puerto Rico. 
Chapter 1

Introduction

Page 35 GAO-06-541 Puerto Rican Fiscal and Economic Trends

required to report detailed information regarding their assets, liabilities, 

and capital to the OCFI through a computerized “CALL report” data system. 

Appendix I describes our analysis of the financial data.

We also used data provided by Puerto Rico’s Government Development 

Bank to show trends in Puerto Rican government borrowing in the U.S. and 

local capital markets. The consensus of the government and private sector 

financial experts whom we interviewed was that all Puerto Rican 

government bonds that qualify for tax exemption under Section 103 of the 

IRC, such as bonds that are issued for the purpose of capital improvement 

projects, are sold in the U.S. market. All other Puerto Rican government 

bonds that are taxable in the United States but tax exempt in Puerto Rico 

are sold in the local market. The Government Development Bank was able 

to provide us with a complete and detailed accounting of each of their debt 

issues and to identify which ones did or did not qualify for the U.S. tax 

exemption.

Changes in Possessions 

Corporation Activity

In order to examine changes in the activities of possessions corporations 

operating in Puerto Rico since the early 1990s, we constructed several 

databases from an assortment of tax return data we obtained from IRS and 

Puerto Rico’s Department of Treasury. Our principal source of data was 

IRS’s Statistics of Income unit (SOI), which compiles comprehensive data 

on possessions corporations every other year. We obtained the complete 

set of these biennial databases from 1993 through 2003 and used 

information from SOI to identify those possessions corporations that 

operated in Puerto Rico. For the first stage of our analysis, we linked the 

biennial records for each individual corporation by its employer 

identification number (EIN) so that we could identify any data gaps for 

specific corporations in particular years and so we could complete a 

second, more complicated data analysis (described below). We filled in 

missing data for individual corporations to the extent possible from other 

IRS files and through imputations based on surrounding-year data. The 

extent of the imputations were minimal relative to the population totals we 

report. We used the final database on 656 possessions corporations that 

operated in at least 1 year between 1993 and 2003 to report on changes over 

time in the aggregate income, tax credit, and total assets of this population 

of corporations and to show how these particular variables were 

distributed across different industries. We also used data from the past four 

Economic Censuses of Puerto Rico (1987, 1992, 1997, and 2002) compiled 

by Census to show how the importance of possessions corporations in 

Puerto Rico’s manufacturing sector has changed over time.
Chapter 1

Introduction

Page 36 GAO-06-541 Puerto Rican Fiscal and Economic Trends

For the second stage of our analysis, we focused on a subpopulation of the 

largest groups of affiliated possessions corporations operating in Puerto 

Rico. For each of these groups we compiled data on other affiliated 

corporations (i.e., those sharing the same ultimate parent corporations) 

that also operated in Puerto Rico, but were not possessions corporations. 

The objective of this analysis was to assess the extent to which the large 

corporate groups that accounted for most of the activity of possessions 

corporations remained active in Puerto Rico, even as the operations of 

their possessions corporations were being phased out. We started by 

identifying the 77 largest groups of possessions corporations in terms of 

the amount of credit they earned, their total income, and their total assets. 

These large groups gave us a subpopulation that accounted for over 90 

percent of the tax credit and income earned and over 90 percent of the 

assets owned by possessions corporations between 1993 and 2003, and at 

the same time reduced the number of corporations we had to work with 

from 656 to 172. This reduction in the number of corporations we had to 

work with was important because data limitations caused some of the 

steps in our database development to be very labor intensive.

We used two key data sources to identify and obtain data for the members 

of the large groups that operated in Puerto Rico but which were not 

possessions corporations. The first source was the database in which IRS 

maintained the records of all forms 5471 that had been filed between 1996 

and 2002. (The owners of controlled foreign corporations [CFC] must file a 

separate form 5471 every year for each CFC that they own.) The second 

source was a database that the Puerto Rican Department of Treasury (with 

the assistance of the Government Development Bank) had recently 

transcribed from all Puerto Rican tax returns for tax years 1998 through 

2001 filed by all corporations or partnerships that received tax incentives 

from the Government of Puerto Rico. Officials from the Department of 

Treasury and from the Puerto Rico Industrial Development Company 

(PRIDCO) told us that almost all U.S.- or foreign-owned manufacturing 

corporations operating in Puerto Rico receive tax incentives, as do 

corporations in designated service industries that export products or 

services from Puerto Rico. A total of 1,758 different taxpayers appeared in 

the database for at least 1 of the tax years. We used a series of both 

automated and manual search and matching approaches to link the CFCs 

and other types of companies from these two databases to our 77 large 

corporate groups. We also used information from both databases to 

determine which of the CFCs had operations in Puerto Rico and, in the 

case of CFCs with operations in multiple countries, to make a range of 

estimates for the amount of income they earned in Puerto Rico. The data 
Chapter 1

Introduction

Page 37 GAO-06-541 Puerto Rican Fiscal and Economic Trends

on income, assets, taxes paid, and place of incorporation that we extracted 

from the two databases for these linked corporations allow us to provide a 

more complete picture of the trends in activities of the corporate groups 

that have taken advantage of the possessions tax credit over the years.

Through interviews with officials from the agencies providing the data and 

our own computer checks for internal consistency in the data, we 

determined that the quality of the data was sufficient for the purposes of 

our report when viewed with the cautions we raise at various points in the 

text. One problem that afflicted all of the databases to some degree was 

missing values arising from the fact that IRS and the Puerto Rican 

Department of Treasury could not always obtain every tax return that 

should have been in their databases in a particular year and the fact that 

taxpayers did not always accurately fill in every line of the return that they 

should have. Our access to multiple databases that overlapped to some 

extent enabled us to address this problem by filling in gaps with data from 

an alternative file, making reasonable imputations, or at a minimum 

assessing whether missing values would have made a significant difference 

to our results.

Distribution of Business 

Activity

In order to show how economic activity in Puerto Rico is distributed across 

different forms of businesses, we negotiated a special arrangement with 

IRS and Census that enabled us to disaggregate the data from Census’s 

recently completed 2002 Economic Census of Puerto Rico by categories of 

business entities that are more specifically relevant to tax policymakers 

than the categories Census uses for its own publications. The 2002 

Economic Census collected data on employment, payroll, and other 

economic measures from all nonfarm, private sector employers in Puerto 

Rico, making it a comprehensive enumeration of Puerto Rican businesses. 

We used taxpayer data from IRS and Puerto Rico to determine, in as many 

cases as possible, the type of federal or Puerto Rican income tax return 

each of these employers filed and, in the case of corporations, where they 

were incorporated. We then used this information to place each employer 

into a business entity group, such as possessions corporation, CFC 

incorporated in Puerto Rico, CFC incorporated elsewhere, sole proprietor, 

and so forth. Census then provided us with tabulations of their data for 

each of these groups, disaggregated by industry to the extent that their 

disclosure rules would permit. We developed a coding system and a dataexchange procedure that enabled us to link tax and Census data for 

specific employers in such a way that Census did not have to view 
Chapter 1

Introduction

Page 38 GAO-06-541 Puerto Rican Fiscal and Economic Trends

restricted IRS data and we did not have to view confidential Census data 

for specific survey respondents. (See app. III for details.)

The data that we used to determine the tax filing status and place of 

incorporation for the employers in the Census database came from the IRS 

and Puerto Rico databases described above, plus a couple of additional 

sources. Another important new source of data was IRS’s National 

Accounts Profile (NAP) database, which contains selected information for 

all individuals and businesses that have an EIN. Each employer in Puerto 

Rico has a federal EIN because it must collect Federal Insurance 

Contributions Act (FICA) taxes on behalf of its employees. Consequently, 

we were able to access NAP data for a very high percentage of the 

employers included in the Census. For those employers we were able to 

determine what, if any, federal income tax form they were required to file, 

whether they were included in their parent corporation’s consolidated 

return, and whether or not IRS had identified them as being sole 

proprietors.

The other data sources that we used for this particular analysis included 

sets of income tax returns for some of the businesses operating in Puerto 

Rico that IRS had provided to Census, and a list of CFCs operating in 

Puerto Rico that PRIDCO had compiled. None of the non-Census data 

sources that we used was comprehensive and some of the sources more 

closely met our needs than others. Appendix III describes how we used 

these data to place each employer into a business entity group. For those 

cases where we could not reliably place an employer into a group based on 

tax data or data from PRIDCO we asked Census to place them into certain 

groups based on their survey responses.

Fiscal Comparison To compare the overall tax burden borne by individuals and businesses in 

Puerto Rico with the burden borne by individuals and businesses in the 

states and in the other insular areas, we obtained and analyzed detailed 

data on state and local government revenues from the U.S. Census of 

Governments, data on Commonwealth government revenue from the 

Puerto Rican Department of Treasury, data on municipal tax revenue in 

Puerto Rico from Oficina del Comisionado de Asuntos Municipales, Centro 

de Estadisticas Municipales,10 and revenue data for the other insular areas 

10Ingresos Por Concepto de Patentes Municipales, Ano Fiscal 2001–2002 (Puerto Rico: 

2002).
Chapter 1

Introduction

Page 39 GAO-06-541 Puerto Rican Fiscal and Economic Trends

reported in their 2002 Single Audit reports. We also obtained data on 

federal taxes collected in Puerto Rico and the states from IRS’s 2002 Data 

book.11 (No such data were available for the insular areas.) We compared 

taxes paid on a per capita basis and as a percent of personal income. We 

make our comparison for year 2002 because that is the year of the most 

recent Census of Governments.

We also compared federal expenditures for the states, Puerto Rico, and the 

insular areas using data we obtained from the Consolidated Federal Funds 

Report for Fiscal Year 2002 and the Federal Aid to States for Fiscal Year 

2002. In addition, we report specifically on transfers of excise tax and 

customs duty revenues that the federal government makes to Puerto Rico 

using data obtained from U.S. Customs and the Alcohol and Tobacco Tax 

and Trade Bureau.

To assess the reliability of the data, for the Census and Puerto Rican 

Treasury data we interviewed knowledgeable officials and reviewed 

supporting documentation to understand the internal procedures in place 

to ensure data quality. For the insular areas we compared data reported in 

the Single Audit reports to other published data. We determined that the 

data we obtained from the Puerto Rican Department of Treasury is 

consistent with what was reported in the Commonwealth’s Comprehensive 

Annual Financial Report. Although we found the data reliable for the 

purpose of our engagement, we note certain limitations in the data. In 

particular, all the state and local data compiled by Census are as-reported 

by cognizant government officials responsible for financial matters in each 

of the political entities and may not have been subjected to any internal or 

external accuracy checks. Checks performed by Census on its data are for 

completeness and consistency with internal and external sources. The 

independent auditor’s statement in the Single Audit reports for the insular 

areas indicated that the auditors generally could not verify the accuracy of 

reported information. In addition, federal, state, and insular area fiscal 

years differ, so the data do not cover exactly the same period of time.

Federal Social Programs Interviews with federal agencies and prior GAO work provided the basis 

for our description of the application of the principal U.S. federal social 

programs to Puerto Rico residents, relative to the states, and the other 

11We did not include the federal corporate tax in our comparison because the location where 

that tax is collected may not be closely related to where the burden of the tax falls.
Chapter 1

Introduction

Page 40 GAO-06-541 Puerto Rican Fiscal and Economic Trends

insular areas. To select the social programs included in this report we 

consulted with GAO experts in the areas of health care policy; education, 

workforce, and income security policy; and financial markets and 

community investment policy. With the help of these experts, we arrived at 

a list of the principal federal social programs, which we then pared down, 

based on program availability in Puerto Rico and expenditure level in 

Puerto Rico. We relied on prior GAO work and interviews with federal 

agency officials to determine how each program is applied in Puerto Rico, 

relative to the other areas. We used program-level data, supplied by federal 

agencies, to report program expenditures for fiscal year 2002. We selected 

fiscal year 2002 because in chapter 6 of this report, we provide a more 

complete analysis of the revenue and expenditures of Puerto Rico, the 

states, and the other insular areas using the year of the most recent Census 

of Governments, 2002.

Our methodologies for each objective were discussed with experts 

including those from the Office of the Comptroller General of Puerto Rico, 

Puerto Rico’s Government Development Bank, Puerto Rico’s Planning 

Board, Puerto Rico’s Office of the Commissioner of Insurance Institutions 

and Puerto Rico’s Office of the Commissioner of Financial Institutions. 

Federal-level experts include those from Census and IRS. Our work was 

performed from February 2004 to April 2006 in accordance with generally 

accepted government accounting standards.
Page 41 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax Chapte2r

Individuals who are residents of Puerto Rico or other U.S. insular areas and 

who earn income only from sources outside of the states generally pay no 

federal income tax; however, their wages are all subject to Social Security 

and Medicare taxes, and wages paid to residents of Puerto Rico and the 

U.S. Virgin Islands also are subject to federal unemployment tax. 

Corporations organized in Puerto Rico, like those organized in the other 

U.S. insular areas, are generally treated for U.S. tax purposes as if they 

were organized under the laws of a foreign country. Until this year, special 

rules enabled corporations organized in the United States that met certain 

conditions to reduce the federal tax payable on income earned in and 

repatriated from Puerto Rico and other insular areas.

U.S. Tax Treatment of 

Insular Area Residents 

with U.S.-source 

Income and U.S. 

Residents with Insular 

Area-source Income 

Varies by Area

Individuals residing in an insular area and who earn income only from 

sources there file one income tax return there and are required to pay 

income tax only to that area. The U.S. income tax treatment of U.S.-source 

income of residents of an insular area (which does not include income 

earned in the insular areas, other than that earned by U.S. government 

employees) depends on the area:

• Residents of American Samoa and Puerto Rico must pay U.S. income 

tax on all their income from sources outside American Samoa or Puerto 

Rico, respectively, if such income exceeds the federal filing threshold.1

The U.S. government retains the tax collected from residents of Puerto 

Rico, but is required to transfer the tax collected from residents of 

American Samoa to its government. 

• Residents of Guam and CNMI owe income tax to the territory and 

Commonwealth, respectively, on their U.S.-source income; the 

governments of these Commonwealths and territories are required to 

transfer a portion of this tax revenue to the U.S. government if the 

resident’s income exceeds certain income thresholds. 

• Generally, the U.S. government does not tax, or receive any tax revenue 

from U.S. Virgin Island residents who have U.S.-source income so long 

as such residents report all of their income, identify the source of their 

income, and pay their income taxes to the U.S. Virgin Islands. 

1

Generally, residents of an insular area cannot claim the earned income tax credit or the 

child tax credit. An exception is that bona fide residents of Puerto Rico with three or more 

children who pay social security taxes may be eligible for the child tax credit. 
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 42 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The U.S. income tax treatment of U.S. residents with Commonwealth- or 

insular area–source income also depends on the insular area:

• U.S. residents with income from Puerto Rico or American Samoa are 

subject to U.S. federal tax on that income. They also pay tax on that 

income to Puerto Rico or American Samoa, respectively, and receive a 

foreign tax credit against their U.S. tax liability for this amount.

• U.S. residents with income from Guam or CNMI owe U.S. income tax on 

that income; the federal government is required to transfer a portion of 

the tax revenue received from Guam and CNMI residents back to the 

respective territory and Commonwealth. 

• U.S. residents who earn income in the U.S. Virgin Islands must file 

identical tax returns with both the government there and the U.S. 

government; each government’s share of the revenues is based on where 

the income was earned. 

While FICA Taxes Are 

Imposed on Wages 

Paid to Employees in 

All Insular Areas, 

Unemployment 

Insurance Tax Applies 

Only to Wages Paid in 

Puerto Rico and U.S. 

Virgin Islands

The Federal Insurance Contributions Act2 imposes wage-based taxes on 

employers and employees in the United States and the Commonwealths 

and territories to support Social Security and Medicare. The employment 

upon which taxes are collected includes services performed in the United 

States and the insular areas. Taxes collected under the act are not 

transferred to the treasuries of the insular areas. 

The Federal Unemployment Tax Act imposes3 a tax on wages paid to 

employees, based on wages paid. Puerto Rico and the U.S. Virgin Islands 

are the only insular areas covered by the Act. The proceeds of the tax are 

used to support the federal-state unemployment compensation program 

and are not transferred to the treasuries of either area. 

2

26 U.S.C. § 3101 et seq. (2004). 

3

26 U.S.C. § 3301 et seq. (2004).
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 43 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Taxation of 

Corporations 

Incorporated in the 

United States

The federal government taxes a U.S. corporation on its worldwide income 

(reduced by any applicable foreign income tax credit), regardless of where 

the income is earned. When the tax is due depends on several factors, 

including whether the income is U.S.- or foreign-source and, if it is foreign 

income, on the structure of the corporation’s business operations. 

However, since 1976, and through taxable years beginning prior to 

December 31, 2006, U.S. corporations with a domestic subsidiary 

conducting a trade or business in insular areas could qualify to receive 

significant tax benefits through the possessions tax credit.4

 Prior to taxable 

years beginning in 1994, the credit effectively exempted from U.S. taxation 

all possession-source income of a qualified possessions corporation. 

Dividends repatriated from a wholly-owned possessions corporation to the 

mainland parent qualified for a 100 percent deduction, thus allowing taxfree repatriation of possession income. The credit also exempted qualified 

possession-source investment income (QPSII), which is certain income the 

possessions corporation earned from financial investments in U.S. 

possessions or certain foreign countries. The credit for qualified research 

expense was also allowed for such research conducted by a possessions 

corporation.

Starting in taxable years beginning in 1994, the amounts of possessions tax 

credits that a possessions corporation could claim were capped. Under the 

cap, a possessions corporation had to choose between two alternatives—a 

“percentage limitation” option or an “economic activity limitation” option. 

In 1996, the possessions tax credit was fully repealed for taxable years 

beginning after 2005. Existing possessions corporations could continue to 

claim the possessions tax credit for tax years beginning prior to 2006. 

These existing credit claimants, however, were subject to an income cap5

based on the average business income that the corporation earned in a 

possession during a specified “base period.” A possessions corporation 

electing the percentage limitation was subject to the income cap beginning 

in 1998 and a possessions corporation electing the economic limitation was 

4

Section 936 is the section of the Internal Revenue Code that describes the credit. Because 

Section 936 refers to the Commonwealths and territories as “possessions,” we refer to them 

in this manner in this section of the report. Under Section 936, it was possible for a domestic 

corporation owned by individuals to qualify for the credit. 

5

A possessions corporation that is an existing credit claimant for Guam, American Samoa, 

or CNMI is not subject to the income cap.
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 44 GAO-06-541 Puerto Rican Fiscal and Economic Trends

subject to the income cap beginning in 2002. Only QPSII earned before 

July 1, 1996, qualified for the credit for tax years beginning after 

December 31, 1995. 

Taxation of 

Corporations 

Incorporated outside 

the United States

Corporations organized outside the United States, including corporations 

organized in Puerto Rico and the other insular areas,6

 are generally treated 

as foreign corporations for U.S. tax purposes. These corporations are taxed 

on their U.S. source earnings—the tax paid generally depends on whether 

the income is “effectively connected” with the conduct of a trade or 

business within the United States, but income from insular areas is not 

subject to U.S. tax. 

Foreign corporations pay U.S. tax at two rates—a flat 30 percent rate is 

withheld on certain forms of nonbusiness gross income from U.S. sources, 

and a tax is imposed at progressive rates on net income from a U.S. trade or 

business.7

 Corporations in Puerto Rico must pay the 30 percent 

withholding tax; corporations in the other insular areas do not pay the 

withholding tax if they meet certain tests that establish close connections 

with the insular area in which the corporation was created. U.S.-source 

dividends paid to corporations organized in Puerto Rico are subject to a 10 

percent withholding tax provided that the same tests mentioned above are 

satisfied and the withholding tax on dividends paid to the U.S. corporations 

is not greater than 10 percent. 

Corporations organized under the laws of an insular area may be treated as 

a controlled foreign corporation (CFC) for U.S. income tax purposes. To 

qualify as a CFC, the corporation must be more than 50 percent U.S.-

owned, taking into account only U.S. shareholders that meet a 10 percent 

stock ownership test. Gross income from the active conduct of business in 

Puerto Rico or elsewhere outside of the United States is not taxed until it is 

repatriated to the U.S. shareholders in the form of dividends. Subject to 

certain limitations, these shareholders are entitled to a credit for any 

foreign income taxes paid by the CFC with respect to the earnings 

distributed. 

6

A possessions corporation that is an existing credit claimant for Guam, American Samoa, 

or CNMI is not subject to the income cap. 

7

Most interest income is exempt from the withholding tax.
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 45 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Certain types of passive income, such as dividends and interest, earned by 

CFCs are currently includable in the income of the U.S. shareholders, 

under subpart F of the U.S. Tax Code, even though those amounts are not 

actually distributed to them.8

 These shareholders are, subject to certain 

limitations, also entitled to a credit for foreign income taxes paid with 

respect to the amounts includible in income under subpart F. 

Certain kinds of income received by a CFC organized under the laws of an 

insular area are not considered subpart F income: 

• income received from the sale in the insular area of personal property 

manufactured by the CFC in that area,

• dividend or interest income received from a related corporation9 also 

organized under the laws of that insular area, and

• rents or royalties from a related corporation received by a CFC 

organized under the laws of an insular area for the use of property in the 

insular area where the CFC is organized. 

The allocation of gross income, deductions, and credits between related 

taxpayers, such as intercompany sales from a CFC to a U.S. domestic 

parent, is subject to transfer pricing rules that are designed to prevent 

manipulation of the overall tax liability. 

Deduction for Income 

from Domestic 

Production Activities 

In 2004, in response to a long-running dispute with the European Union, 

Congress repealed the extraterritorial income (ETI) exclusion and enacted 

a deduction relating to income attributable to domestic production

8

The subpart F rules generally “attempt to prevent” (or negate the tax advantage from) 

deflection of certain types of moveable income, either from the United States or from a hightax foreign country, into another jurisdiction that is a tax haven or that has a preferential tax 

regime for certain types of income. In this report we refer to the passive income earned by 

CFCs, subject to these rules, as “subpart F income.” If the CFC’s subpart F income, which 

may include dividends, interest, royalties, rents, and annuities, does not exceed the lesser of 

5 percent of gross income or $1 million, this income currently income by the U.S. 

shareholder.

9

Generally, a related corporation is any corporation which controls, or is controlled by, the 

CFC, or the corporation and the CFC are controlled by the same person, through ownership 

of more than 50 percent of the stock. 
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 46 GAO-06-541 Puerto Rican Fiscal and Economic Trends

activities.10 For purposes of the ETI exclusion, the United States included 

Puerto Rico. Puerto Rico is not included, however, in the definition of U.S. 

for purposes of the deduction for domestic production.

Goods Imported to 

Insular Areas Are 

Generally Exempt from 

U.S. Excise Taxes, but 

a Special Tax Is 

Imposed on Goods 

Made in Puerto Rico 

and U.S. Virgin Islands

Merchandise imported into an insular area from the United States is 

exempt from U.S. excise taxes. The only U.S. excise taxes that apply to 

products imported into any of the insular areas from another country are 

those where specific language extends the tax beyond the “United States,” 

which is generally defined, for tax purposes, as only the states. This 

language exists for a tax on petroleum (an environmental tax), a tax on 

certain vaccines, a tax on certain chemicals, and a tax on certain imported 

substances. 

If any revenue from these excise taxes is collected in American Samoa, 

Puerto Rico, or the U.S. Virgin Islands, the U.S. government retains the 

revenue. The governments of Guam or CNMI receive any revenue from 

these taxes collected in their respective territory and Commonwealth. 

There is a special “equalization” U.S. excise tax on articles manufactured in 

Puerto Rico or the U.S. Virgin Islands and exported to the United States 

equal to the tax that would have been imposed had the articles been 

manufactured in the United States. Subject to the limitations described 

below for distilled spirits, the U.S. Treasury returns all the revenue from the 

tax on articles manufactured in Puerto Rico to the Treasury there except 

the amounts needed to pay refunds and drawbacks11 to manufacturers and 

the amount needed to cover its enforcement expenses. The return to the 

U.S. Virgin Islands also excludes amounts needed to pay refunds and 

drawbacks, plus one percent of the total tax collected. All U.S. excise taxes 

collected on articles manufactured from Guam and CNMI and exported to 

the United States must be transferred to their respective territory and 

Commonwealth governments.

A special limitation applies for the U.S. excise tax on distilled spirits 

manufactured in Puerto Rico and the U.S. Virgin Islands and exported to 

10Pub. L. No. 108-357 (2004).

11A drawback is the refund of all or part of customs duties, or domestic tax paid on imported 

merchandise that was subsequently either exported or manufactured into a different article 

and then reexported.
Chapter 2

U.S. Federal Tax Treatment of Puerto Rico 

and Other Insular Areas Varies by Area and 

Type of Tax

Page 47 GAO-06-541 Puerto Rican Fiscal and Economic Trends

the United States. The tax rate ordinarily applied to rum is $13.50 per proof 

gallon exported, of which $10.50 per proof gallon is returned to the 

appropriate insular area. Puerto Rico and the U.S. Virgin Islands also share 

revenue from the U.S. excise tax collected on all rum imported into the 

United States from a foreign country. Their respective shares are 

proportionate to the relative sizes of their rum exports to the United States 

during the prior fiscal year. Puerto Rico’s share, however, cannot exceed 

87.626889 percent or be less than 51 percent while the U.S. Virgin Islands’ 

share cannot exceed 49 percent nor drop below 12.373111 percent.

U.S. Government Is 

Responsible for 

Collecting Customs 

Duties in Puerto Rico 

and Helps Collect 

Duties in U.S. Virgin 

Islands

The U.S. government collects duties on goods imported into “U.S. customs 

territory,” which encompasses the states and Puerto Rico, unless they are 

exempt. U.S. customs duties collected in Puerto Rico are deposited in a 

special U.S. Treasury account. After deductions for refunds and the 

expenses of administering customs activities in Puerto Rico, the remaining 

amounts are transferred to the treasury there.

Although the U.S. Virgin Islands are not in “U.S. customs territory,” the U.S. 

government helps collect local duties there. These collections are 

transferred to the government of the U.S. Virgin Islands after items such as 

operational expenses are deducted. The U.S. government has authority to 

administer and enforce collection of custom duties in American Samoa, 

upon request of the Governor. Guam and CNMI administer and enforce 

their own customs policies and procedures. Items imported into “U.S. 

customs territory” from American Samoa, Guam, CNMI, and the U.S. Virgin 

Islands are subject to U.S. customs duties unless the items are exempt. 
Page 48 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico Chapte3r

The economic well-being of Puerto Rican residents, measured in terms of 

either per capita or median income, remains well below that of residents of 

the states. The relative progress that the Puerto Rican economy has made 

since 1980 is difficult to measure with precision for a number of reasons, 

including tax-induced distortions in how U.S. corporations have reported 

income earned in the Commonwealth. The low rate of labor participation is 

a crucial issue in Puerto Rico’s economic performance, and the rate of 

investment appears insufficient to significantly reduce the disparity 

between mainland and Puerto Rican incomes.

Measuring Economic 

Progress in Puerto 

Rico Is Challenging but 

the Income of 

Commonwealth 

Residents Remains 

Well Below That of U.S. 

Residents

As shown in figure 9, Puerto Rico’s per capita GDP of about $21,000 in 2005 

remained well below U.S. per capita GDP of about $41,000. GDP is a broad 

measure of overall income or economic activity occurring within a nation’s 

borders in a given year. According to the Puerto Rican and U.S. national 

income and product accounts, this measure has grown more rapidly in 

Puerto Rico than in the United States since 1980, when viewed on a per 

capita basis after adjustments for inflation. However, for a number of 

reasons, the growth rate of real (meaning inflation-adjusted) GDP likely 

does not represent a very accurate measure of changes in the economic 

well-being of Puerto Rican residents. 

First, as a result of U.S. tax provisions and a development strategy pursued 

by successive Puerto Rican governments to use local tax incentives to 

attract investment by U.S. and foreign firms, a significant amount of the 

investment income included in GDP is paid out to U.S. and foreign 

investors. In figure 9, the income earned by nonresidents is approximately 

represented by the gap between Puerto Rican GDP and Puerto Rican GNP. 

GNP is a measure of the total amount of income earned by residents in a 

given year from sources within and from outside of the country. In contrast 

to Puerto Rico, GDP has been consistently about the same as GNP in the 

United States, which indicates that the amount of income earned abroad by 

U.S. residents is close to the amount of income earned by foreign owners of 

assets located in the United States. As of 2005, Puerto Rico’s per capita 

GNP of about $14,000 remained well below the U.S. level of about $41,000.

Second, using the possessions tax credit, U.S.-based groups of affiliated 

corporations (i.e., those owned by a common U.S. parent corporation) with 

certain types of operations in Puerto Rico have had incentives to attribute 

as much net income to those operations as is legally permissible, rather
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 49 GAO-06-541 Puerto Rican Fiscal and Economic Trends

than to related operations in the United States.1 Moreover, the nature of 

these incentives has changed during the period covered by our review. 

Consequently, the income reported by these corporations to have been 

earned in Puerto Rico in a given year may overstate the actual economic 

importance of their Puerto Rican production, and changes in income over 

the years may reflect not only changes in the economic activity of these 

corporations, but also changes in how corporations have computed their 

Puerto Rican source income. Some of the data reported later in this chapter 

suggest that this so-called “income shifting” has taken place. This particular 

issue affects data on GDP and income and possibly value added for 

corporations owned by U.S. parent corporations; it should not affect GNP 

or income and value added for Puerto Rican-owned corporations.

Third, as is the case for any country, the scale of the informal, or 

underground, economy in Puerto Rico is difficult to measure. If the 

informal economy in Puerto Rico is large relative to the informal economy 

in the United States, as some analysts believe, a relatively large amount of 

economic activity in Puerto Rico may not be reflected in national income 

and labor market statistics. As discussed below, the presence of a large 

informal economy may be one explanation of low reported labor force 

participation rates in Puerto Rico. Analysts who have recently looked at 

this issue disagree on the size of the informal economy and on whether it 

has been growing as a share of the total economy. The size and any growth 

in the informal economy in Puerto Rico, relative to that in the United 

States, would affect comparisons between levels and growth in per capita 

income earned in the two jurisdictions. 

Lastly, as acknowledged by the Puerto Rico Planning Board, there are 

problems with some Puerto Rican price indices, which cause an unknown 

degree of inaccuracy in the inflation adjustments to the long-term trend 

data on the Puerto Rican economy and, therefore, some imprecision in the 

real growth rates of key economic indicators that are stated in terms of 

dollar values. Most concerns center on the Puerto Rican consumer price 

index (CPI, a measure of prices on consumer goods) and the fact that the 

market basket of goods used to compute the index has not been updated 

since the 1970s. This means that the index will tend to overstate price 

changes. In the analysis in this chapter, we have used the Puerto Rican 

gross product deflator—a broad measure of how prices have changed on 

1

These incentives and the flexibility that corporate groups have had in identifying the 

geographic sources of their income are discussed in more detail in ch. 4.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 50 GAO-06-541 Puerto Rican Fiscal and Economic Trends

average for goods and services in the economy—for our inflation 

adjustments. Although analysts within and outside of Puerto Rico’s 

Planning Board, which produces the deflator, consider it to be less 

problematic than the CPI, they still have concerns relating to fact that the 

CPI is one of the components used in estimating the deflator and the fact 

that methodologies for other components are also outdated.2

Given the concerns with the Puerto Rican deflator, there is a question as to 

whether that measure or the U.S. gross product deflator more accurately 

accounts for the changes in prices in Puerto Rico. The U.S. deflator shows 

slower price increases over this period than does the Puerto Rican deflator. 

For this reason, we also report some results based on the use of the U.S. 

deflator in cases where they differ notably from those based on the Puerto 

Rican deflator.

When comparing the trends in real per capita GNP in Puerto Rico and the 

United States from 1980 to 2005, the choice of deflators does make a 

difference. Over that period, inflation-adjusted per capita income increased 

at an average annual rate of 1.9 percent in the United States, while it rose at 

1.5 percent in Puerto Rico if the Puerto Rican deflator is used. However, if 

the U.S. deflator is applied to Puerto Rican GNP, annual real per capita 

GNP rose by 2.5 percent annually, faster than the growth in the United 

States. Real per capita GDP rose more rapidly in Puerto Rico than in the 

United States, regardless of which deflators are used. U.S. GDP rose at an 

annual average rate of 1.9 percent from 1980 to 2005, while the average 

annual growth rate for Puerto Rico was 2.1 percent using the Puerto Rican 

deflator and 3.2 percent using the U.S. deflator. 

2

The Planning Board has contracted with several consultants to complete a diagnostic 

analysis of all of their national income and product account methodologies, including those 

for the deflator. The Board is also negotiating a memorandum of agreement with the U.S. 

Bureau of Economic Analysis (BEA) for the latter’s assistance in this effort.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 51 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 9: U.S. and Puerto Rican Per Capita GDP and GNP, 1980–2005

Note: Figures were adjusted for inflation using U.S. and Puerto Rican gross product deflators. 

Figure 10 shows the composition of Puerto Rican GDP over time and the 

trend in net income payments abroad. GDP consists of expenditures on 

personal consumption, investment, government consumption of goods and 

services, and net exports (the value of exports minus the value of imports). 

The figure shows that net exports have risen substantially from 1980 to 

2005 as a share of GDP, and consumption, which is largely determined by 

Puerto Rican income, has fallen as a share of GDP. 

Figure 10 also shows net income payments abroad, expressed as a share of 

GDP. This series represents the amount of income paid to foreign owners 

of capital located in Puerto Rico, minus income earned by Puerto Ricans 

from investments outside of Puerto Rico. GNP differs from GDP by this 

amount. For Puerto Rico, the net outflow of income has increased as a 

share of GDP over the period, increasing the gap between GDP and GNP. 

Dollars (constant 2005)

Source: GAO analysis of U.S. Bureau of Economic Analysis and Puerto Rican Planning Board data.

Fiscal year

U.S. GNP per capita

U.S. GDP per capita

Puerto Rican GDP per capita (Puerto Rican deflator)

Puerto Rican GDP per captia (U.S. deflator)

Puerto Rican GNP per capita (Puerto Rican deflator)

Puerto Rican GNP per capita (U.S. deflator)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 52 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 10: Composition of Puerto Rican GDP and Net Income Payments Abroad, 1980–2005

Note: Consumption, investment, government, and net export expenditures constitute GDP. 

Puerto Rico Relies 

Heavily on 

Nonresidents to 

Finance Local 

Investment

Figure 11 shows the relationship between savings and investment in Puerto 

Rico. The components of total national saving in Puerto Rico are personal 

saving, government saving, business saving through retained earnings, and 

depreciation. The figure shows that investment in Puerto Rico has been 

greater than national saving, highlighting again that investment in Puerto 

Rico has been significantly financed by foreign sources. Since 2001, 

government saving has fallen and undistributed corporate profits have 

risen significantly. The personal saving rate as measured in the Puerto 

Rican national accounts has been negative since 1980. If transfers from

-60

-40

-20

0

20

40

60

80

100

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Share of GDP (percent)

Source: GAO analysis of Puerto Rico Planning Board data.

Fiscal year

Personal consumption

Government consumption

Gross investment

Net imports/exports

Net income payments to rest of world
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 53 GAO-06-541 Puerto Rican Fiscal and Economic Trends

foreigners to residents of Puerto Rico are underreported, however, the 

official data for income and saving would also be understated.3

Figure 11: Puerto Rico’s Gross Domestic Investment and National Saving, 1980–2005

Note: Data for 2005 are preliminary.

We cannot provide a comprehensive picture of the trends in various 

components of U.S. and foreign investment in Puerto Rico because data are 

not available for one of the most important components—direct foreign 

investment, for which corporations obtain financing from within their own

3

Bosworth and Collins, “Economic Growth in Puerto Rico.”

Share of GNP (percent)

Source: GAO analysis of Puerto Rico Planning Board data.

 Fiscal year

Gross domestic investment

Gross national saving

0

5

10

15

20

25

30

35

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 54 GAO-06-541 Puerto Rican Fiscal and Economic Trends

affiliated groups, rather than through financial institutions.4 We can, 

however, report trends for foreign funds flowing through key types of 

financial institutions and the Puerto Rican government. In the next two 

chapters, we will also provide some information on investments by 

important subpopulations of corporations.

Over the past decade, the amount of nonresident funds flowing into 

depository institutions in Puerto Rico has increased steadily. Figure 12 

shows Puerto Rico’s depository institutions’ liabilities between 1995 and 

2004, and figures 52 and 53 in appendix II show the shift in deposits and 

debt, respectively. The composition of deposits has changed significantly 

with “exempt investments” by possessions corporations (which in the past 

had been encouraged by a special component of the possessions tax credit) 

being replaced by deposits obtained through brokers that sell certificates 

of deposits for the banks in the U.S. capital market. (Fig. 54 in app. II shows 

those offsetting trends.)

Figure 13 below shows that the share of assets held by depository 

institutions in the United States and foreign countries has also increased 

over the past decade. A large part of this growth can be attributed to the 

increase in U.S. and foreign securities investments. Loans made by Puerto 

Rico’s depository institutions, which we assume to be primarily local, have 

also increased steadily. Figures 55 and 56 in appendix II show these two 

trends. 

4

Puerto Rico’s Planning Board stopped compiling data on U.S. and foreign direct investment 

in the Commonwealth in the early 1990s after the Commonwealth government devolved the 

property tax to the municipalities. Changes in the location and storage technology for 

property tax records that accompanied this change in responsibility for the tax made it 

difficult for the Board to continue its investment estimation, which relied heavily on these 

property tax records.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 55 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 12: Puerto Rico’s Depository Institutions’ Liabilities, 1995–2004

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Unknown

U.S. and foreign

Puerto Rico

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions (OCFI) data. 

Internal inconsistencies prevent reliable allocation between U.S. and foreign, unknown

and Puerto Rico in years 1995–1998.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 56 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 13: Puerto Rico’s Depository Institutions’ Assets, 1995–2004

Notes: The allocation of total assets includes the assumption that 95 percent of depository institution 

loans are made locally in Puerto Rico and 5 percent in the United States or foreign countries. 

Figures were adjusted for inflation using Puerto Rico’s gross product deflator.

Puerto Rican government debt has increased steadily over the past decade. 

Between 1995 and 2005, Puerto Rico’s real total public debt outstanding 

increased from $25.6 billion to $36.4 billion (see fig. 14 below).5

 Most of 

Puerto Rican public debt is sold in the U.S. market, but the amount sold 

within Puerto Rico has increased steadily since 1999. In 2005 an estimated 

$31.6 billion was sold in the United States, and $4.8 billion was sold locally 

in Puerto Rico. 

In appendix II we include both the breakdown of debt payable by the 

government and debt issued by the government but repaid by others (such 

5

For the purpose of this section, real numbers were calculated using the Puerto Rican GNP 

deflator.

0

20,000

40,000

60,000

80,000

100,000

120,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Unknown

U.S. and foreign

Puerto Rico

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions (OCFI) data. 
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 57 GAO-06-541 Puerto Rican Fiscal and Economic Trends

as the federal government or the private sector) because there are 

differences of opinion about what should be termed “government debt”

(see figs. 58 and 59). An example of this type of debt is the series of bond 

issues linked to The Children’s Trust Fund between 2001 and 2005, all of 

which are backed by assets from the United States Attorney General’s 1999 

Master Tobacco Settlement Agreement. Between 1995 and 2005, total debt 

issued by the Puerto Rican government, but payable by others, increased 

from an estimated $6.6 billion to an estimated $7.1 billion in 2005.

Figure 14: Puerto Rico’s Total Real Government-issued Debt, by Market of 

Purchaser, 1995–2005

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator.

Amount outstanding (dollars in billions)

Source: GAO analysis of Government Development Bank of Puerto Rico data.

Fiscal year ending June 30

Local

U.S.

0

5

10

15

20

25

30

35

40

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 58 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Investment Appears 

Insufficient to Reduce the 

U.S.-Puerto Rican Income 

Gap

Figure 15 shows the level and composition of gross investment spending in 

Puerto Rico from 1980 to 2005. During the recession of the early 1980s, 

investment fell below 10 percent of GDP by 1983. Thereafter, investment 

recovered and remained around 15 percent of GDP for a number of years 

until a period of rapid growth in largely private-sector investment in the 

late 1990s pushed the share close to 20 percent of GDP by 2000. Investment 

rates have fallen back to about 15 percent of GDP most recently.

Figure 15: Puerto Rican Gross Fixed Investment as a Percent of GDP, 1980–2005

Note: Gross fixed investment does not include changes in inventories or subtract depreciation.

If Puerto Rico’s investment rate remains at recent levels, the gap between 

U.S. and Puerto Rican per capita incomes is unlikely to diminish. The U.S. 

investment rate, including both private investment and a measure of 

government investment, has been about 19 percent of GDP in recent years. 

Continuation of these relative investment rates implies that the per capita 

Share of GDP (percent)

Source: GAO analysis of Puerto Rico Planning Board data.

Fiscal year

0

5

10

15

20

25

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Government and public enterprises

Private housing

Private machinery

Private structures
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 59 GAO-06-541 Puerto Rican Fiscal and Economic Trends

income gap is unlikely to narrow significantly, unless capital formation is 

augmented by increases in employment, education, training, or other types 

of productivity improvements. 

Figure 16 shows a breakdown of Census data on capital spending in the 

manufacturing sector for 1987, 1992, 1997, and 2002.6

 The data show that 

investment in manufacturing dipped significantly between 1992 and 1997, 

before rebounding by 2002. This slump in investment does not appear in 

the Planning Board investment data for private sector investment shown in 

figure 15. The Planning Board data cover more sectors than do the Census 

data; however, investment in manufacturing should represent a substantial 

portion of the investment in private structures and machinery. 

6

Census does not report capital spending for other sectors. Between the 1997 and 2002 

reports, Census switched from using the Standard Industrial Classification (SIC) system to 

the North American Industrial Classification System (NAICS) in order to place businesses 

into particular industrial categories. As a result, the scope of the industries covered in the 

2002 census is not strictly comparable to the scopes for the earlier reports. However, those 

technical changes should not be a significant factor in the changes in investment depicted in 

fig. 16.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 60 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 16: Puerto Rico’s Capital Expenditures as a Percentage of Gross Domestic 

Product, 1987–2002

Data on Value Added 

and Income Show That 

the Pharmaceuticals 

Industry Has 

Significantly Increased 

Its Dominance of 

Puerto Rican 

Manufacturing but 

Evidence Suggests 

That These Measures 

May Be Overstated

Although both Census data on value added and Puerto Rican government 

data on domestic income show that the pharmaceutical industry has 

significantly increased its already dominant position in the manufacturing 

sector since the early 1990s, evidence suggests that income shifting within 

U.S.-owned corporate groups likely has resulted in overstatements of the 

importance of the manufacturing sector, as a whole, and the 

pharmaceutical industry, in particular, when measured in terms of value 

added or income. Unfortunately, it is difficult to know the extent of any 

overstatement in these economic variables. Evidence is mixed as to 

whether the extent of the overstatement increased as the pharmaceutical 

operations of possessions corporations were shifted over to other types of 

businesses. Other measures of economic activity, such as employment and 

capital spending, should not be affected by income shifting and, therefore, 

can be used to either support or challenge conclusions based on measures 

of value added and income.

Share of GDP (percent)

Years

All manufacturing

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1987, 1992,

and 1997, published data from the 2002 Economic Census of Island Areas, and custom tabulations from the

2002 Economic Census of Island Areas provided by the U.S. Census Bureau.

0

1

2

3

4

5

6

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 61 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Census data on value added and Puerto Rican Planning Board data on 

domestic income both show steady and significant growth in the 

pharmaceutical industry. Figure 17 shows that value added in the 

pharmaceutical industry more than doubled in real terms from 1992 to 

2002, while value added in all other manufacturing industries, as a whole, 

declined. Figure 18 shows that the chemical industry, which consists 

mainly of pharmaceuticals, saw its share of net manufacturing domestic 

income increase from around 50 percent in 1992 to over 60 percent in 2005.

Figure 17: Value Added for Puerto Rican Manufacturing Industries, 1987–2002

Constant 2005 dollars in billions

Year

All other manufacturing

Pharmaceuticals

Source: GAO analysis of published data from the 2002 Economic Census of Island Areas

and the Economic Census of Outlying Areas for 1987,1992, and 1997.

0

10

20

30

40

50

60

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 62 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 18: Share of Net Manufacturing Domestic Income in Puerto Rico, 1980–2005

Note: 2005 figures are preliminary. 

The strong reported performance of the pharmaceutical sector is the 

reason that the manufacturing sector has been able to slightly increase its 

share of domestic income, while the share of income of most other 

manufacturing industries has declined. Manufacturing’s share of income, 

shown in figure 19, greatly exceeds its share of employment, as shown in 

figures 23 and 24. Some of the difference may be attributable to a higher 

level of labor productivity in manufacturing than in other sectors. Recent 

research suggests, however, that reported levels of value added in Puerto 

Rican manufacturing are implausible. For example, the official data imply 

that labor’s share of value added in manufacturing fell from an average of

0

10

20

30

40

50

60

70

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Share of income (percent)

Source: GAO analysis of Puerto Rico Planning Board data.

Fiscal year

Chemicals

Machinery-metals

Food

Other manufacturing

Apparel
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 63 GAO-06-541 Puerto Rican Fiscal and Economic Trends

50 percent from 1950 to 1970 to only 14 percent in 2004. Similar declines 

are not evident in data for other sectors or in U.S. manufacturing statistics.7

Figure 19: Shares of Puerto Rico’s Domestic Income by Sector, 1980–2005

Note: 2005 figures are preliminary.

Over the years, several analysts have concluded that the incentives 

provided by the possessions tax credit have led U.S. corporate groups to

7

Bosworth and Collins, The Economy of Puerto Rico: Restoring Growth.

Share of income (percent)

Source: GAO analysis of Puerto Rico Planning Board data.

Fiscal year

0

10

20

30

40

50

60

70

80

90

100

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Other sectors

Government

Finance, insurance, real estate

Manufacturing
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 64 GAO-06-541 Puerto Rican Fiscal and Economic Trends

shift income to Puerto Rican affiliates.8 Until the mid-1990s, the credit 

essentially allowed profits earned from qualified Puerto Rican operations 

to be returned to the mainland free of federal tax (even when largely 

exempted from Puerto Rican income taxes). In addition, one option under 

the credit allowed the U.S. corporate parent to apply a 50-50 split of their 

combined taxable income from the sale of products to third parties if the 

products were derived from an intangible asset, such as a patent, invention, 

formula, or trademark. Although a substantial portion of this income can be 

attributed to manufacturing intangibles developed and owned by the U.S. 

corporate parent, there is no requirement that the allocation of income 

from such manufacturing intangible assets reflect where costs were 

actually generated, or where value was actually added to the products. 

Consequently, corporate groups that produced pharmaceuticals, or other 

products whose final values are largely based on the value of intellectual 

property, were given flexibility under the law to shift net income to the 

possession corporations operating in Puerto Rico or another insular area. 

This shifting of income and value added to the Puerto Rican operations of 

possessions corporations ultimately gets reflected in economic data 

compiled by the Puerto Rican government, which is based heavily on data 

pulled from samples of corporate tax returns, and possibly in data that 

Census collects in its surveys of employers for the economic censuses, if 

the economic data the employers provide are based on their tax accounts. 

The nature of income shifting changed significantly after 1995, when the 

phaseout of the possessions tax credit began. Some of the corporate 

groups that owned possessions corporations in Puerto Rico began to close 

or reduce operations in those corporations and shift production to CFCs 

located on the island. Corporate groups still have some incentives to retain 

operations in Puerto Rico rather than shift that production to the United 

States. First, Puerto Rico responded to the phaseout of the credit by 

increasing the generosity of its own tax incentives. Second, manufacturing 

income earned from an active trade or business by the CFCs is not subject 

to federal tax unless it is repatriated to the United States. A change in 

8

Grubert and Slemrod developed a theoretical model and then tested it empirically using 

corporate tax data for 1987. They concluded that “a large fraction of U.S. investment in 

Puerto Rico is due to the income shifting opportunities.” Harry Grubert and Joel Slemrod, 

“The Effect of Taxes on Investment and Income Shifting to Puerto Rico,” The Review of

Economics and Statistics, vol. 80, no. 3 (August 1998), pp. 365–373. More recently, 

Bosworth and Collins also conclude that income shifting has been significant. Bosworth and 

Collins, “Economic Growth in Puerto Rico” in The Economy of Puerto Rico: Restoring 

Growth, ed. Susan M. Collins, Barry P. Bosworth, and Miguel Soto-Class (Washington, D.C.: 

The Brookings Institution, 2006). 
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 65 GAO-06-541 Puerto Rican Fiscal and Economic Trends

income shifting has also occurred because the rule for arbitrarily splitting 

net income 50-50 between Puerto Rican and U.S. operations does not apply 

to CFCs. Nevertheless, corporate groups may be able to shift income to 

Puerto Rico through the manner in which they set prices on goods and 

services transferred among affiliated corporations. 

Data from the last four economic censuses of manufacturing in Puerto 

Rico, presented in figure 20, show that valued added per employee in the 

pharmaceutical industry was already at least twice as high as the ratio for 

all other industries in 1987 and 1992. The difference between the 

pharmaceutical industry and the other industries grew larger in 1997 and 

then broadened dramatically by 2002. The 2002 figure of $1.5 million for 

value added per employee in Puerto Rican pharmaceutical manufacturing 

was three times as high as the ratio for the U.S. pharmaceutical industry for 

the same year. Moreover, while the U.S. ratio grew only 8 percent in real 

terms between 1997 and 2002, the Puerto Rican ratio grew by 65 percent 

over that same period.9

The data on value added per employee by type of business in figure 21 

suggest that the sharp increase in that measure between 1997 and 2002 may 

have been a direct result of the shift in pharmaceutical operations from 

possessions corporations to CFCs. (These data are derived from a special 

research effort in which we obtained assistance from Census and IRS to 

aggregate data from the 2002 Economic Census of Puerto Rico by 

particular types of business entities, including possessions corporations 

and CFCs.)10 The value added per employee of $4.2 million for 

pharmaceuticals CFCs incorporated outside of Puerto Rico was 

dramatically higher than for any other type of business in Puerto Rico. The 

next highest ratio was $1.6 million for pharmaceuticals CFCs incorporated 

in Puerto Rico, which was still considerably higher than the ratio of 

$0.9 million for possessions corporations in the pharmaceutical industry. 

That data, combined with the data in figure 20, suggest a significant change 

in transfer pricing by large pharmaceuticals groups, which makes it 

difficult to say how much of the strong reported growth in output and 

income in the Puerto Rican pharmaceutical industry, and in the 

9

If the U.S. gross product deflator is used instead of the Puerto Rican one to adjust the valueadded figures, the Puerto Rican ratio would be about three times as high as the U.S. ratio, 

but it would have grown by 89 percent between 1997 and 2002.

10Most of the results of that research effort are reported in ch. 5. App. III provides a 

description of the methodology for that analysis. 
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 66 GAO-06-541 Puerto Rican Fiscal and Economic Trends

manufacturing sector as a whole, represents an increase in actual 

economic activity.

Figure 20: Value Added per Employee for Key Puerto Rican Manufacturing 

Industries, 1987–2002 

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1987 1992 1997 2002

Constant 2005 dollars

Year

Pharmaceuticals

All other manufacturing (residual)

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997, published data from the

2002 Economic Census of Island Areas, and custom tabulations from the 2002 Economic Census of Island Areas provided by the

U.S. Census Bureau.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 67 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 21: Value Added per Employee in Puerto Rico by Type of Business, 2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Data on rates of return on assets for possessions corporations and CFCs in 

the chemical industry do not confirm the conclusion that a dramatic 

change in income-shifting practices occurred as CFCs replaced 

possessions corporations in the industry. We used data from federal tax 

returns to compare various rates of return for CFCs and possessions 

corporations in the Puerto Rican chemical industry. The comparisons we 

were able to make for 1997 through 2001 did not show a consistent 

difference between the two types of corporations. The ratios of gross 

profits (the closest tax-data equivalent to value added) to total assets for 

CFCs were significantly higher than those for possessions corporations in 

both 1997 and 1999, but the ratios were very close together in 2001. We also 

compared the gross and net operating rates of return of the two types of 

Constant 2005 dollars in millions

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

All other employers

Sole proprietors

Pass-through entities

Corporations of

 type unknown

 Other corporations

incorporated in Puerto Rico

 CFCs incorporated

 outside of Puerto Rico

CFCs incorporated

 in Puerto Rico

Other U.S. corporations

Possessions corporations

All employers

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided

by the U.S. Census Bureau.

Type of business

All manufacturing

Pharmaceuticals
Chapter 3

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Page 68 GAO-06-541 Puerto Rican Fiscal and Economic Trends

corporations and found that neither type dominated the other one 

consistently across the years. The results of our analysis are presented in 

appendix IV. 

International Trade 

Plays a Large Role in 

Puerto Rico’s Economy

International trade plays a much larger role in the Puerto Rican economy 

than it does in the U.S. economy. While the output of an economy (GDP) 

depends on the difference between exports and imports (net exports), the 

size of exports and imports relative to GDP are indicators of the 

importance of trade to the economy. For the United States, exports of 

goods and services averaged about 10 percent of GDP between 1980 and 

2005. Imports increased from about 10 percent of GDP in the early 1980s to 

about 16 percent of GDP in 2005. While potential distortions in trade data 

should be kept in mind, the share of exports and imports has been 

substantially greater in Puerto Rico. For Puerto Rico, the value of exported 

goods and services as a percentage of GDP grew from about 70 percent of 

GDP in the 1980s to about 80 percent in 2005. Imports fell as a share of GDP 

from about 70 percent to about 63 percent in recent years. 

As reported in the Puerto Rican national accounts, the value of 

pharmaceutical imports and exports increased substantially from 1996 to 

2005. The value of imported pharmaceuticals increased from about 9 

percent of all merchandise imports to about 33 percent during that period. 

As a share of GDP, the value of imported pharmaceuticals increased from 

about 4 percent to about 15 percent. The value of pharmaceutical exports 

rose rapidly as a share of merchandise exports—from about 27 percent to 

about 61 percent. As a percentage of GDP, the value of pharmaceutical 

exports rose from about 14 percent to about 42 percent. However, as noted 

above, a significant portion of the recorded increase in Puerto Rico’s trade 

surplus may reflect changes in transfer pricing, with artificially low values 

for Puerto Rico’s imports and high values for Puerto Rico’s exports, rather 

than increased activity. 

While the United States is the largest trading partner for Puerto Rico for 

exports and is a large source of Puerto Rican imports, the foreign country 

share of imports to Puerto Rico has been growing since 1995. In 2005, 

slightly less than half of the value of imports to Puerto Rico came from 

foreign countries. About 80 percent of Puerto Rico’s exports go to the 

United States. Puerto Rico’s overall trade surplus reflects a trade surplus 

with the United States as Puerto Rico exports more to the United States 

than it imports from the United States, and a smaller trade deficit with the 

foreign countries. 
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 69 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Official Statistics 

Indicate That 

Unemployment Has 

Been Much Higher in 

Puerto Rico Than in 

the United States and 

Labor Force 

Participation Has Been 

Lower 

Figure 22 shows the unemployment rates and labor force participation 

rates for the United States and Puerto Rico from 1980 to 2005. The 

unemployment rate has been significantly higher in Puerto Rico than in the 

United States, and the labor force participation rate has been much lower. 

Figure 22: U.S. and Puerto Rican Labor Participation and Unemployment Rates, 1980–2005

Academics and economists from research institutions have offered several 

possible explanations for the relatively low labor force participation rate in 

0

10

20

30

40

50

60

70

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Rate of participation/unemployment (percent)

Source: U.S. BLS and Puerto Rico Planning Board data.

Fiscal year

U.S. participation rate

Puerto Rican participation rate

Puerto Rican unemployment rate

U.S. unemployment rate
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 70 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Puerto Rico and attempted to determine which of these factors might be 

important. While the low labor force participation rate is seen as a crucial 

issue for the economic performance of Puerto Rico, there is no consensus 

on its cause.11

Possible explanations for the low labor force participation rate include 

• the migration of Puerto Rican citizens with the most interest in 

participating in the labor force to seek higher wage employment in the 

United States, leaving residents that have relatively less attachment to 

the labor force;12

• the fact that government programs that are in place, such as the 

Nutrition Assistance Program (NAP, the Puerto Rican food stamp 

program) and disability insurance, can discourage work, while the U.S. 

program that encourages labor force participation—the Earned Income 

Tax Credit—is not a part of the tax system in Puerto Rico; 

• the fact that the U.S. minimum wage applies in Puerto Rico may 

discourage business demand for lower-skilled workers, who are likely to 

make up a larger share of the potential work force in Puerto Rico than in 

the United States; and

• that a relatively large share of Puerto Ricans work in the informal 

economy and that this work is not reflected in economic statistics. 

Regarding this last issue, analysts have raised issues with the quality of the 

Puerto Rican labor force survey, which is the data source for the 

unemployment rate and the labor force participation rate. The survey is 

designed to be similar to the U.S. Current Population Survey (CPS), from 

which the U.S. data are derived, but the questions regarding labor market 

11An analysis of Census data indicates that employment rates have been lower in Puerto 

Rico than in the United States across gender and education level. Steven J. Davis and Luis 

Rivera-Batiz, “The Climate for Business Development and Employment Growth in Puerto 

Rico,” in Collins, Bosworth, and Soto-Class, The Economy of Puerto Rico: Restoring 

Growth. Several other chapters in the book also consider the labor force participation issue.

12During the 1980s and 1990s the number of men migrating to the United States is estimated 

to be slightly larger than the number of women. Most migrants to the United States were 

estimated to be in their twenties. For age groups older than 45, Census estimated that more 

individuals migrated to Puerto Rico from the mainland than migrated from the island to the 

United States.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 71 GAO-06-541 Puerto Rican Fiscal and Economic Trends

activity in the surveys differed and the question asked by the Puerto Rico 

household survey may not have captured work activity in the informal 

sector of the economy as well as the question asked in the CPS.13 On the 

other hand, labor force participation as measured in the decennial 

census—which uses the same question as the CPS—has also been low and 

the estimate for 2000 was lower than the household survey estimate for 

that year.14 The Bureau of Labor Statistics (BLS) has been working with the 

Puerto Rican government to improve the household survey in several 

areas. In addition, labor force data for 2005 are scheduled to be reported 

for Puerto Rico as a part of the Census Bureau’s American Community 

Survey effort. 

Educational attainment can play an important role in developing labor 

market skills. Data on educational attainment in Puerto Rico is collected in 

the decennial census and can be compared to data for the United States. 

These data show that the gap in educational attainment between Puerto 

Rico and the United States narrowed significantly during the 1990s. 

Nonetheless, in 2000, 40 percent of the population over 25 in Puerto Rico 

had not finished high school, which is nearly the double the U.S. share. At 

the same time, about 38 percent of adults reported having at least some 

college education (see table 4).

13Maria Enchautegui and Richard B. Freeman, “Why Don’t More Puerto Rican Men Work? 

The Rich Uncle (Sam) Hypothesis,” in Collins, Bosworth, and Soto-Class, The Economy of 

Puerto Rico: Restoring Growth.

14The 47.3 percent labor force participation rate reported in the Census for 1990 in Puerto 

Rico was close to the 45.5 percent reported by the Puerto Rico Planning Board for fiscal 

year 1990. Census found a 40.7 percent participation rate in 2000, while the Planning Board 

reported a 46.2 rate for fiscal year 2000. Census has reported much higher unemployment 

rates in 1990 and 2000 (20.4 and 19.2 percent) than have been reported by the Planning 

Board for those years.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 72 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 4: Educational Attainment in the U.S. and Puerto Rico, 1990 and 2000

Source: Census.

Recent research concluded that there is a substantial mismatch between 

Puerto Rico’s industry structure and the educational achievement of its 

population.15 While the mean years of schooling among Puerto Rican adults 

was substantially below that of any state in the last three censuses, the 

average years of schooling of people typically employed by the industries 

operating in Puerto Rico exceeds that of at least two-thirds of the states. 

The researchers suggest that the Puerto Rican economy has failed to 

generate jobs that fit the educational qualifications of the Commonwealth’s 

population. In some sense, therefore, Puerto Rico’s “missing jobs” can be 

found in labor intensive industries heavily reliant on less-educated 

workers. The authors conclude that the Possessions Tax Credit and other 

federal tax incentives contributed to an industry structure that is poorly 

aligned with the sort of job opportunities needed by Puerto Rico’s 

population.

Annual data on employment in Puerto Rico come from two sources: the 

Puerto Rico household survey, and the BLS establishment survey. The 

Puerto Rico household survey has consistent sector definitions across time 

and includes the self-employed. The establishment survey data are limited 

to employees and reflect the new North American Industry Classification 

System industry definitions. In the figures that follow, we aggregated some 

of the industry categories and show the distribution of employment by 

sector. Both surveys show employment in Puerto Rico generally increasing 

since 1991 and show manufacturing employment declining since 1995. As 

shown in figure 25, data from the Census of Manufacturing for Puerto Rico 

for 1997 and 2002 also indicate a decline in manufacturing employment. 

Manufacturing employment fell by about 27 percent from 1995 to 2005, 

Educational attainment (percent of 

population 25 years old and over)

1990 2000

United States Puerto Rico United States Puerto Rico

High school or more 75.2 49.7 80.4 60.0

Some college or more 45.2 28.7 51.8 37.7

Bachelor’s degree or more 20.3 14.3 24.4 18.3

Advanced degree 7.2 3.6 8.9 4.7

15Davis and Rivera-Batiz, “The Climate for Business Development and Growth in Puerto 

Rico.”
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 73 GAO-06-541 Puerto Rican Fiscal and Economic Trends

according to establishment survey data.16 Both the household and 

establishment data sources show that the government sector employs a 

large percentage of workers—about 23 percent in the household survey 

and about 30 percent in the establishment survey. 

For the United States, manufacturing employment has been falling, both in 

absolute numbers of employees and as a percentage of all employees. 

Between 1980 and 2005, manufacturing employment fell by about 4.5 

million employees (about 24 percent). From 1995 to 2005, manufacturing 

employment fell by about 3 million employees (about 17 percent). As of 

2005, manufacturing employees represented about 10.7 percent of all 

employees. Government employees constituted about 16 percent of total 

employees in the United States, down from about 18 percent in 1980.

16BLS data for the first two months of 2006 indicate a further drop in manufacturing 

employment. However, these data are not seasonally adjusted.
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 74 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 23: Puerto Rican Employment by Sector—Household Survey, 1980–2005

Employed persons (thousands)

Source: GAO analysis of Puerto Rico Planning Board data.

Fiscal year

0

200

400

600

800

1,000

1,200

1,400

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Trade and public utilities

Services

Government

Finance, insurance, real estate

Agriculture and construction

Manufacturing
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 75 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 24: Puerto Rican Employment by Sector—Establishment Survey, 1991–2005

Employees (thousands)

Source: GAO analysis of U.S. BLS data.

Fiscal year

0

200

400

600

800

1,000

1,200

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Trade, transport, public utilities, information

Services

Government

Finance activities

Other goods (natural resources, construction)

Manufacturing
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 76 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 25: Employment in Puerto Rican Manufacturing Industries, 1987–2002 

Since 1980, Real Per 

Capita Personal 

Income in Puerto Rico 

Has Not Grown 

Enough to 

Substantially Reduce 

the Gap between U.S. 

and Puerto Rican 

Living Standards

Although the likely imprecision of price deflators for Puerto Rico leaves the 

exact growth rate of real per capita personal income there difficult to 

determine, the rate has not been sufficient to substantially reduce the gap 

between U.S. and Puerto Rican living standards. Puerto Rican per capita 

personal income is well below that in the United States (see fig. 26). 

Number of employees

Years

Pharmaceuticals

All other manufacturing

Source: GAO analysis of published data from the 2002 Economic Census of Island Areas and the

Economic Census of Outlying Areas for 1987,1992, and 1997.

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 77 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 26: U.S. and Puerto Rican Real Per Capita Personal Income, 1980–2005

Note: Figures were adjusted for inflation using U.S. and Puerto Rican gross product deflators.

As we did in comparing U.S. and Puerto Rican GDP and GNP, we adjusted 

aggregate per capita personal income data using both U.S. and Puerto 

Rican price deflators. The growth rate in per capita personal income is 

somewhat higher in Puerto Rico than in the United States when the U.S. 

deflator is used to adjust Puerto Rican per capita personal income for 

inflation. In this case, the average annual percentage increase in Puerto 

Rican per capita personal income was 2.1 percent while U.S. per capita 

personal income rose by 2.0 percent on average per year. When the Puerto 

Rican deflator is used to make adjustments for inflation, Puerto Rican per 

capita personal income grew at a slower rate (1.1 percent) than in the 

United States (2.0 percent). The difference arises because the U.S. price 

deflator increased less than the Puerto Rico price deflator. Using both price 

indices serves to illustrate the sensitivity of the calculation to the index 

used. 

In addition, private income transfers from Puerto Rico emigrants now 

living in the United States made to Puerto Rican residents may be 

Dollars (constant 2005)

Source: GAO analysis of U.S. BEA and Puerto Rico Planning Board data.

Fiscal year

U.S. personal income

Puerto Rican personal income (Puerto Rican deflator)

Puerto Rican personal income (U.S. deflator)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 78 GAO-06-541 Puerto Rican Fiscal and Economic Trends

understated, which would lead to an understatement of Puerto Rican 

personal income. As U.S. citizens, Puerto Ricans are free to migrate to the 

mainland United States and return as they wish. According to Census 

estimates, net migration from Puerto Rico to the United States in the 1980s 

totaled about 126,000.17 During the 1990s, net migration was estimated to 

be about 111,000.

Census data show the distribution of income in Puerto Rico and the United 

States and the percentages of individuals and families with incomes below 

official poverty lines.18 The median household income in 1999 was $41,994 

in the United States and $14,412 in Puerto Rico. In 1999, 48.2 percent of 

households in Puerto Rico had incomes below the poverty level, which was 

nearly four times the U.S. share, as shown in table 5. 

Table 5: Poverty Status in the United States and Puerto Rico, Percentage below 

Poverty Levels, 1999

Source: Census.

As the disparity between average incomes in the United States and Puerto 

Rico suggests, a much higher percentage of Puerto Rican households is in 

the lower income categories. In 1999, only about 10 percent of U.S. 

17Matthew Christenson, “Evaluating Components of International Migration: Migration 

Between Puerto Rico and the United States,” Population Division Working Paper no. 64 

(Washington, D.C.: U.S. Census Bureau, January 2002),

www.census.gov/population/www/techpap.html.

18The Census income data do not include the value of in-kind government transfer 

payments.

Percent

United States Puerto Rico

All ages 12.4 48.2

Related children under 18 16.1 58.3

5–17 years 15.4 58.5

Population 65 and over 9.9 44.0

All families 9.2 44.6

Families with female head and at 

least one child 34.3 70.8
Chapter 3

Trends in Production, Income, and Other 

Economic Indicators for Puerto Rico

Page 79 GAO-06-541 Puerto Rican Fiscal and Economic Trends

households had annual incomes below $10,000, compared to 37 percent of 

Puerto Rican households (see table 6). 

Table 6: Income Distribution of Households in the United States and Puerto Rico, 

1999

Source: Census.

Note: Income data do not include capital gains and the value of in-kind government benefits and 

employer contributions.

The distribution of income is more unequal in Puerto Rico than in the 

United States. Economies in general have a small share of households 

receiving a disproportionately large share of income. As a result, the ratio 

of mean to median household income exceeds 1.0. As an indication of the 

greater degree of income inequality in Puerto Rico, the ratio of mean to 

median household income in 1999 was 1.69 in Puerto Rico19 compared to 

1.35 in the United States. 

Household income United States Puerto Rico

Less than $10,000 9.5 37.1

10,000–24,999 19.2 32.9

25,000–49,999 29.4 19.9

50,000–74,999 19.4 5.7

75,000–99,999 10.2 2.0

100,000–149,999 7.7 1.4

150,000–199,999 2.2 0.4

200,000 or more 2.4 0.6

19U.S. Census Bureau, “QT-P32. Income Distribution in 1999 of Households and Families: 

2000” (United States and Puerto Rico), http://factfinder.census.gov.
Page 80 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations Chapte4r

Possessions corporations have played an important role in the Puerto 

Rican economy, particularly in the manufacturing sector, where they 

accounted for well over half of valued added throughout the 1990s. Most of 

the possessions tax credit and income earned by possessions corporations 

in Puerto Rico has been earned by corporations in the pharmaceutical 

industry. Once the possessions tax credit was repealed, many of the large 

corporate groups that owned possessions corporations in Puerto Rico 

began to shift their operations to other types of business entities. Although 

the various tax and economic census data that we present in this chapter 

have significant limitations, we believe that, together, they form the basis 

for a reasonably accurate picture of the broad changes that have occurred 

in Puerto Rico’s manufacturing sector over the past two decades. Those 

data indicate that much of the decline in activity of possessions 

corporations in the manufacturing sector was offset by the growth in other 

corporations, so that some measures of aggregate activity remained close 

to their 1997 levels. For example, value added in manufacturing remained 

fairly constant between 1997 and 2002. Most of the offsetting growth was 

concentrated in the chemical industry, which is dominated by 

pharmaceuticals.

Possessions 

Corporations 

Dominated Puerto 

Rico’s Manufacturing 

Sector up until the Late 

1990s

Possessions corporations continued to dominate Puerto Rican 

manufacturing through the mid-1990s, despite the legislative changes that 

made the possessions tax credit significantly less generous after 1993. 

According to the 1992 Economic Census of Puerto Rico Manufacturing, 

these corporations accounted for 42.2 percent of employment and 64.3 

percent of valued added in the manufacturing sector (as seen in fig. 27). By 

the next economic census in 1997, possessions corporations’ share of value 

added had increased to 72 percent, while their share of employment 

remained little changed at 40.8 percent.1

 This pattern of growth up to 1997 

is also apparent in the data from the federal tax returns of possessions 

corporations shown in figure 28. The aggregate total income, gross profits, 

and net income of possessions corporations operating in Puerto Rico all 

increased slightly between 1993 and 1997 (after adjusting for inflation), 

although there was a small decline in the corporations’ total assets.

1

This growth in value added and stability in employment was true in absolute terms, as well 

as in terms of the percentage shares shown in fig. 27.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 81 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 27: Share of Possessions Corporations in Value Added and Employment in 

Puerto Rican Manufacturing, 1987–2002

0

10

20

30

40

50

60

70

80

1987 1992 1997 2002

Percent of sector

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1987, 1992, and 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the 2002 Economic Census

of Island Areas provided by the U.S. Census Bureau.

Year

Possessions value added

Possessions employment

61.6%

64.3%

42.2%

72.0%

40.8%

26.7%

31.8%

38.2%

Industry classifications

changed from SIC to NAICS
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 82 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 28: Income and Assets from the Tax Returns of Possessions Corporations

Operating in Puerto Rico, 1993–2003

The growth in possessions corporation activity occurred despite the 

limitations that Congress placed on the possessions tax credit after 1993 

and a decline in the number of corporations claiming the credit. Figure 29 

shows that those limitations significantly reduced the generosity of the 

credit. Possessions corporations earned about 20 cents of credit for each 

dollar of income they earned in 1993, but only half that amount by 1997. 

Over that period, the number of corporations claiming the credit for 

operations in Puerto Rico fell from 378 to 291 and the amount of credit 

claimed declined from $5.8 billion to $3.2 billion.

The decline in possessions corporation income, value added, and 

employment began after the Small Business Job Protection Act of 1996, 

which placed additional limits on the amount of credit that corporations 

could earn and, more importantly, repealed the credit completely for tax 

years beginning after 1995, subject to a 10-year phaseout. The generosity of 

the credit reached a low of less than 7 cents per dollar of income by 1999. 

0

10

20

30

40

50

60

70

1993 1995 1997 1999 2001 2003

Source: GAO analysis of data from IRS.

Year

Aggregate total assets

Aggregate total income

Aggregate gross profits

Aggregate net income

Constant 2005 dollars in billions
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 83 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The number of corporations claiming the credit fell to 124 by 2003 and the 

amount of credit they claimed that year fell to $1.1 billion. Moreover, in 

contrast to the period leading up to 1997, the aggregate total income, gross 

profits, and net income earned by possessions corporations all declined by 

more than 50 percent between 1997 and 2003, while their total assets 

declined by almost 30 percent. The significantly decreased importance of 

possessions corporations is also apparent in the most recent economic 

census data (fig. 27), showing that these corporations accounted for only 

26.7 percent of manufacturing value added and only 31.8 percent of 

manufacturing employment in 2002.

Figure 29: The Ratio of Possessions Tax Credit to Total Income Earned by 

Possessions Corporations in Puerto Rico, 1993–2003

Note: The rate of credit per dollar of income increased slightly between 1999 and 2003, as 

corporations with relatively low rates of credit were more likely to stop operating as possessions 

corporations (and, therefore, drop out of the population represented in fig. 29) than those with higher 

rates.

0

0.05

0.10

0.15

0.20

0.25

1993 1995 1997 1999 2001 2003

Dollars

Source: GAO analysis of data from IRS. 

Year

Ratio of credit to total income
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 84 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 30: The Number of Corporations in Puerto Rico Claiming the Possessions

Tax Credit and the Amount Claimed, 1993–2003

The Pharmaceutical 

Industry Has 

Dominated the Use of 

the Possessions Tax 

Credit in Puerto Rico

Most of the possessions tax credit and income earned by possessions 

corporations in Puerto Rico has been earned by corporations in the 

pharmaceutical industry. Figure 31 shows that pharmaceuticals 

corporations earned over half of all the credit earned each year from 1995 

through 2003. Figure 32 shows that these corporations earned an even 

larger share of the aggregate gross profit earned by possessions 

corporations in each of those years. Manufacturers of beverages and 

tobacco products, medical equipment, and computers, electronics, and 

electrical equipment were also heavy users of the credit during this period, 

though not nearly to the same extent as pharmaceuticals manufacturers. 

Both of these figures are based on data for possessions corporations in the 

77 largest corporate groups operating in Puerto Rico. (See the following 

section.)

0

1

2

3

4

5

6

7

1993 1995 1997 1999 2001 2003

0

50

100

150

200

250

300

350

400

Constant 2005 dollars in billions Number

Source: GAO analysis of data from IRS.

Year

Credit claimed

Number claiming credit
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 85 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 31: Industry Shares of the Possessions Tax Credit in Puerto Rico, 1993–2003

0

20

40

60

80

100

1993 1995 1997 1999 2001 2003

Percent share

Year

Nonmanufacturing

Other manufacturing

Apparel

Beverages and tobacco

Medical equipment

Computers, electronics, and electrical equipment

Pharmaceuticals

Source: GAO analysis of data from IRS.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 86 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 32: Industry Shares of Gross Profits Earned by Possessions Corporations in 

Puerto Rico, 1993–2003

Businesses Have a 

Variety of Options for 

Continuing Operations 

in Puerto Rico after 

They Cease Operating 

as Possessions 

Corporations

Parent corporations have a number of options for conducting business in 

Puerto Rico if they wish to do so after termination of the possessions tax 

credit. Large corporate groups are believed to have used at least four 

different approaches to rearranging their overall corporate structure 

(including the possessions corporation and their Puerto Rican operations) 

in anticipation of termination of the possessions tax credit. The U.S. federal 

tax consequences of these approaches vary as follows:

• The possessions corporation loses its 936 status but remains a 

subsidiary incorporated in the United States and is consolidated into 

0

20

40

60

80

100

1993 1995 1997 1999 2001 2003

Percent share

Year

Nonmanufacturing

Other manufacturing

Apparel

Beverages and tobacco

Medical equipment

Computers, electronics, and electrical equipment

Pharmaceuticals

Source: GAO analysis of data from IRS.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 87 GAO-06-541 Puerto Rican Fiscal and Economic Trends

its parent’s federal tax return. The parent corporation includes the 

relevant income and expenses of the subsidiary when computing its 

own federal taxes. Tax attributes, such as carryovers of certain 

accumulated losses, of the former possessions corporation would be 

governed by applicable IRS regulations and guidance.

• The possessions corporation liquidates into its parent (i.e., it no 

longer remains a separate corporate entity). Generally, if the parent 

satisfies certain ownership requirements, no gain or loss would be 

recognized to either the parent or the subsidiary for U.S. federal income 

tax purposes. The domestic parent would inherit and take into account 

certain items of the former possessions corporation, such as earnings 

and profits, net operating and capital loss carryovers, and methods of 

accounting. No foreign tax credit is allowed for any foreign taxes paid in 

connection with the liquidation, and the deduction of certain losses and 

other tax attributes may be limited. 

• The possessions corporation is converted into or replaced by a CFC. 

This change can occur if the possessions corporation reincorporates 

and conducts business as a CFC; if it sells or contributes most of its 

assets to a CFC; or if it winds down its operations as its parent 

corporation starts up a new CFC to operate in Puerto Rico. Any income 

that the replacement CFC earns from the active conduct of business in 

Puerto Rico or elsewhere outside of the United States generally is not 

taxed until it is repatriated to the U.S. shareholders in the form of 

dividends. A number of tax consequences arise in cases where the 

possessions corporation actually reincorporates as a CFC.2

 There are 

also significant tax issues (discussed further below) relating to the 

transfer of assets (through either a contribution or a sale) from 

possessions corporations to CFCs.

• The possessions corporation is converted into or replaced by a limited 

liability corporation (LLC) or partnership. An LLC can elect to be 

treated as a corporation, as a partnership, or as a “disregarded entity.” If 

the LLC elects to be treated as a corporation, its net earnings would be 

included either individually or, if required to file a consolidated return, 

2

These consequences include the loss of any foreign tax credit or deduction with respect to 

any possessions tax credit or other foreign tax imposed on accumulated earnings of the 

corporation. Reincorporation also causes adjustments to the alternative minimum tax and 

could cause the recapture of certain losses.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 88 GAO-06-541 Puerto Rican Fiscal and Economic Trends

on its parent’s return. If it chose partnership treatment, the LLC itself 

would generally not be subject to federal income tax but its income, 

deductions, gains, and losses would be distributed to its members, who 

would include such amounts in calculating their federal income tax. If 

the LLC is treated as a disregarded entity, its income, deductions, gains, 

and losses are included on the member’s federal tax return.

Parent corporations could substantially change the manner in which 

income from their Puerto Rican business operations were treated for 

federal tax purposes even without making a formal change in the legal 

status of their possessions corporations. The parents could simply reduce 

production by their possessions corporations and start up or expand 

production in other forms of businesses operating in Puerto Rico. We used 

tax return data from both IRS and the Treasury of Puerto Rico to track 

changes in the activity of possessions corporations, as well as to assess the 

extent to which declines in that activity have been offset by increases in the 

activity of affiliated businesses operating in Puerto Rico. In order to make 

this assessment for a particular group of affiliated corporations, we needed 

to examine data for each member of the group that had operations in 

Puerto Rico.3 Given that considerable effort was required to identify the 

group members that operated in Puerto Rico, we limited our review to the 

largest 77 groups, which included at least one possessions corporation 

between 1993 and 2001. These 77 large groups accounted for over 92 

percent of the credit and income earned by possessions corporations in 

every year from 1993 through 2001 and for over 91 percent of the assets 

owned by such corporations in each of those years. 

The large groups included a total of 172 possessions corporations that we 

tracked between 1993 and 2003.4

 The number of possessions corporations 

that these 77 large groups owned and operated in Puerto Rico declined 

from a high of 146 in 1995 to 58 by 2003. As of 2001, these groups also 

conducted operations in Puerto Rico through 49 CFCs and at least 28 other 

businesses. Fourteen of the groups operated both possessions 

3

By “affiliated corporate group,” we mean a parent corporation and all of its subsidiary 

corporations.

4

The full population of possessions corporations that operated in Puerto Rico in at least one 

of those years was 656. Table 14 in app. IV shows the attributes of the full population of 

possessions corporations, while table 15 shows those of the subset that we examined in 

detail.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 89 GAO-06-541 Puerto Rican Fiscal and Economic Trends

corporations and CFCs in Puerto Rico in 2001. In the following section we 

report on trends in the income and assets of these large corporate groups.

The popular choice of replacing the operations of possessions corporations 

with CFCs offers long-term tax benefits but could entail high initial tax 

costs for some corporations. Many corporate groups have chosen to 

operate in Puerto Rico through CFCs, possibly to take advantage of the 

federal tax deferral on income earned there. Some may have rejected this 

choice because their possessions subsidiaries owned valuable intangible 

assets, such as drug patents or food recipes, and the transfer of these assets 

to a non-U.S. entity, such as a CFC, could have been treated as a taxable 

exchange, possibly resulting in a substantial, one-time tax liability.5

Affiliated groups can avoid this tax if they keep the intangible assets in 

their U.S. firms, rather than transferring them to their new CFCs. However, 

in order for those CFCs to use those intangibles in their production 

processes, they must pay royalties to the U.S. owners and those royalties 

would be subject to federal income tax.

IRS officials have expressed concern that the repeal of section 936 has not 

had its intended effect. Congress repealed section 936 because it was 

viewed as providing an overly generous tax benefit to taxpayers with 

operations in Puerto Rico. However, IRS officials believe that despite the 

repeal of section 936, many taxpayers with operations in Puerto Rico could 

be incurring approximately the same or even lower tax liabilities than they 

did under section 936 by restructuring their activities through CFCs. 

Taxpayers who converted into CFCs may have avoided the tax 

consequences typically associated with such a conversion, namely, tax 

liabilities arising from the transfer of intangibles from possessions 

corporations to CFCs or a significant increase in royalty payments from 

Puerto Rico. One private sector tax expert familiar with the practices of 

U.S. businesses operating in Puerto Rico could not recall any case in which 

a taxpayer reported a transfer of intangibles of any significant value from a 

possessions corporation to a CFC. The expert also told us that the reason 

5

If the possessions subsidiary reincorporates as a foreign corporation, it is treated as having 

sold any marketing or manufacturing intangibles in exchange for payments contingent upon 

productivity, use, or disposition of such property. These payments would be treated as 

ordinary income. If the subsidiary transfers the property while it is still a possessions 

corporation, the payments are included as U.S.-source ordinary income. If the possessions 

election has terminated, the payments would be considered foreign-source ordinary income. 

Source rules are important for domestic corporations to determine whether a foreign tax 

credit is available to offset U.S. income taxes and for a foreign corporation to determine 

whether the income is subject to U.S. income taxation.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 90 GAO-06-541 Puerto Rican Fiscal and Economic Trends

why the IRS has not seen a notable increase in royalty payments from CFCs 

to U.S. firms holding intangibles is that, well before the expiration of the 

possessions tax credit, corporate groups had their existing or newly 

formed CFCs enter into research cost-sharing arrangements with their 

possessions corporations so that they would be codevelopers of new 

intangibles and, thereby, would have certain ownership rights to use the 

technology without paying royalties. The groups also tried to involve their 

CFCs as much as possible in the development of new products through 

other arrangements, such as research partnerships with unrelated 

technology-developing firms.

Some Measures of 

Aggregate 

Manufacturing Activity 

Have Remained 

Constant Despite a 

Decline in Possessions 

Corporation Activity

A combination of tax return and economic census data indicate that the 

decline in income and value added of possessions corporations between 

1997 and 2002 has been largely offset by an increase in the income and 

value added of affiliated corporations that left aggregate income and value 

added roughly constant. Although some evidence of a change in incomeshifting behavior by these corporate groups makes it difficult to say how 

accurately trends in reported income and value-added data represent 

trends in actual economic activity in Puerto Rico, data on employment, 

capital expenditures, and total assets (which should not be distorted by 

income shifting) support the conclusion that a substantial amount of 

possessions corporation activity has been continued by other types of 

businesses. However, most of this continued activity is concentrated in the 

pharmaceutical industry and the decline in possessions corporation 

activity in other industries has not been offset. None of the data we present 

address the question of what corporate activity would have taken place 

during this period if the possessions tax credit had not been repealed.

Tax Return and Economic 

Census Data Indicate That 

Much of the Income and 

Value Added of Possessions 

Corporations Declined 

While That of Affiliated 

Businesses Increased

Tax return data on the affiliated corporate groups that have claimed almost 

all of the possessions tax credit indicate that between 1997 and 2001 at 

least a large portion (and possibly all) of the decline in reported incomes of 

possessions corporations operating in Puerto Rico was offset by increases 

in the reported incomes and total assets of affiliated corporations operating 

in Puerto Rico, particularly that of CFCs. The offset left the income that 

these groups earned in Puerto Rico roughly the same in 2001 as in 1997. 

This finding is consistent with data on value added in manufacturing from 

recent economic censuses of Puerto Rico. 
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 91 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Gross profit, which equals income from sales minus the cost of goods sold, 

is the income measure from tax returns that is closest in definition to the 

value-added measure from census data that we presented earlier.6

 Both of 

these measures may be distorted by income shifting, as we explain in the 

next section; however, value added is considered to be the best measure of 

the economic importance of manufacturing activity. We examined data for 

both of these measures, as well as other measures not distorted by income 

shifting, to assess the extent to which possessions corporation activity has 

been replaced by the activity of other types of businesses.

Figure 33 shows that the aggregate gross profit of the possessions 

corporations in our 77 large groups peaked at $28.8 billion in 1997 and then 

fell to $11.4 billion by 2003. The figure also presents our “lower-bound” 

estimates for the amount of gross profits from Puerto Rico that CFCs 

reported. These estimates include only the profits of those CFCs for which 

we had Puerto Rican tax returns or that appeared to have operations only 

in Puerto Rico because those are the cases where we can be the most 

confident that our figures represent profits attributable only to Puerto 

Rican operations. The gross profits of those CFCs grew from $2.4 billion to 

$7.1 billion between 1997 and 2001.7

 These estimates are likely to represent 

a lower bound for the amount of CFC profits in Puerto Rico because they 

do not include any of the profits for CFCs whose income was difficult to 

allocate between Puerto Rico and other locations. We present alternative 

estimates, labeled “CFC total if allocated by tax ratio,” of the gross profits 

from Puerto Rico of all of the CFCs in our large groups.8

 These more 

comprehensive estimates are not likely to be very precise, but they are 

6

No other expenses, such as employee compensation, interest, taxes, or depreciation, are 

deducted to arrive at gross profits. Although the following discussion relates to the gross 

profits of the various types of businesses, the trends are very similar for the total incomes 

and net incomes of these businesses. Data on the latter two measures of income are 

presented in table 15 in app. IV. The data in figure 33 and in tables 15 through 18, all of which 

contain U.S. tax data, are inflation-adjusted with the U.S. GDP deflator.

7

There were only three years (1997, 1999, and 2001) for which we had federal tax returns for 

both possessions corporations and CFCs. There were only two years (1999 and 2001) for 

which we had both federal and Puerto Rican returns for possessions corporations, CFCs, 

and other types of corporations.

8

These estimates cover all of the CFCs included in our lower bound estimates and then add 

in estimated amounts for the multinational CFCs. The latter estimates are made by 

multiplying the amount of tax paid to Puerto Rico by each CFC (which is reported on their 

federal tax return) by the average ratio of Puerto Rico gross profits over taxes paid to 

Puerto Rico by CFCs for which we did have Puerto Rican tax returns.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 92 GAO-06-541 Puerto Rican Fiscal and Economic Trends

consistent with some of the census data that we present on CFCs in 

chapter 5. The estimates show CFC gross profits growing from $3.0 billion 

to $11.5 billion between 1997 and 2001. Finally, figure 33 also shows the 

gross profits reported on Puerto Rican tax returns by members of the 77 

large groups, other than possessions corporations and CFCs. The gross 

profits of these businesses increased from $3.0 billion to $7.0 billion 

between 1999 and 2001.

Figure 33: Gross Profits Earned by Large Corporate Groups in Puerto Rico, by Type 

of Corporation, 1993–2003

The data in figure 33 indicate that much of the $10.7 billion decline in the 

gross profits of possessions corporations between 1997 and 2001 was offset 

by increases in the profits of affiliated corporations. The lower-bound 

estimates for CFCs grew by $4.7 billion over that period, while the profits

Lower bound for CFCs

CFC total if allocated by tax ratio

Possessions corporations

Other affiliates

0

5

10

15

20

25

30

35

1993 1995 1997 1999 2001 2003

Constant 2005 dollars in billions

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Year
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 93 GAO-06-541 Puerto Rican Fiscal and Economic Trends

of the other affiliates, including LLCs, grew by $3.9 billion between 1999 

and 2001.9 The combined profits of these two sets of businesses, therefore, 

grew by about $8.7 billion. If we use the “tax ratio” estimate for all CFCs, 

the combined growth in profits grew by about $12.5 billion. The gross profit 

of the “other affiliated” businesses is likely to be understated relative to 

those of the possessions corporations because of differences in the income 

definitions used for federal and Puerto Rican tax purposes. For those 

possessions corporations for which we had both federal and Puerto Rican 

returns, the gross profit from the Puerto Rican return averaged about 70 

percent of the gross profit on the federal return. For this reason figure 33 

may understate the extent to which the decline in possessions 

corporations’ Puerto Rican operations has been offset by these other 

affiliates.

Data from recent economic censuses on value added in Puerto Rican 

manufacturing lend additional support to the conclusion that we draw from 

figure 33—that much, if not all, of the decline in income of possessions 

corporations in Puerto Rico between 1997 and 2001 was largely offset by 

increases in the incomes of other types of businesses. Figure 34 shows that 

valued added by possessions corporations in Puerto Rican manufacturing 

followed roughly the same pattern as the gross profits data presented in 

figure 33; it also shows that other types of businesses made up for 

approximately all of the possessions corporations’ decline between 1997 

and 2002.

9

Tax experts, including those in IRS, suggested that one potential explanation for this use of 

LLCs is that the “special allocation rules” under partnership tax law allow corporate groups 

more flexibility in allocating income and expenses within a group. At least one case was 

identified where manufacturing operations in Puerto Rico were held in a partnership owned 

by two partners—one was a possessions corporation, the other was a CFC. This partnership 

allocated the profits from old product lines that qualified for the possessions tax credit to 

the possessions corporation; it passed profits from new product lines that did not qualify for 

the credit to the CFC.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 94 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 34: Value Added for Possessions Corporations and Other Types of 

Employers in Manufacturing in Puerto Rico, 1987–2002

The extent to which the decline in income and value added of possessions 

corporations was offset by the growth of their affiliates varied significantly 

by industry. Figure 35 decomposes the last two columns of figure 34 into 

the chemical industry (which includes pharmaceuticals) and all other 

manufacturing industries. It shows that a significant drop in the value 

added of possessions corporations in the chemical industry was more than 

offset by the substantial growth in value added by other types of 

businesses. In contrast, the value added of both possessions corporations 

and all other types of businesses declined between 1997 and 2002 in the 

remainder of the manufacturing sector, outside of chemicals. 

Constant 2005 dollars in billions

Years

All other

Possessions corporations

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1987, 1992,

and 1997, published data from the 2002 Economic Census of Island Areas, and custom tabulations from the

2002 Economic Census of Island Areas provided by the U.S. Census Bureau.

0

10

20

30

40

50

60

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 95 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 35: Value Added for Possessions Corporations and Other Types of 

Employers in the Chemical Industry and All Other Manufacturing Industries in 

Puerto Rico, 1997–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Our tax data for large corporate groups showed similar variation across 

industries. The corporate groups in the chemicals and medical equipment 

industry group offset a larger proportion of the decline in the income of 

their possessions corporations between 1997 and 2002 with income from 

other types of affiliates operating in Puerto Rico than was the case for large

Constant 2005 dollars in billions

Industry and year

All other types of businesses

Possessions corporations

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the

2002 Economic Census of Island Areas provided by the U.S. Census Bureau.

0

5

10

15

20

25

30

35

40

All other

industries

2002

All other

industries

1997

Chemicals

2002

Chemicals

1997

Industry classifications

changed from SIC to NAICS
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 96 GAO-06-541 Puerto Rican Fiscal and Economic Trends

corporate groups as a whole.10 Trends in the income of possessions 

corporations in the other two industrial groupings that we are able to 

present with our tax data—computer, electronics, and electrical 

equipment; and food and kindred products—were somewhat erratic 

between 1993 and 2001 before declining by 2003. There was negligible to no 

growth in the incomes of CFCs and other types of businesses in these two 

industrial groupings during the period we could observe between 1997 and 

2002. (See tables 17 and 18 in app. IV.)

Data on Capital 

Expenditures, Total Assets, 

and Employment Also 

Indicate That a Substantial 

Amount of Possessions 

Corporation Activity Has 

Been Continued by Other 

Types of Businesses in 

Certain Industries

As we explained in chapter 3, the data on income and value added for 

members of large corporate groups operating in Puerto Rico may be 

distorted by changes in the income reporting practices of these groups 

during the late 1990s. For this reason it is difficult to know how accurately 

trends in reported income and value added represent trends in actual 

economic activity in Puerto Rico. Nevertheless, data on capital 

expenditures, total assets, and employment (which should not be distorted 

by income shifting) support the conclusion that a substantial amount of 

possessions corporation activity has been continued by other types of 

businesses. Much of this continued activity is concentrated in the chemical 

industry, which is dominated by pharmaceutical producers.

The economic census data on capital expenditures on manufacturing plant 

and equipment in figure 36 show that this investment increased 

dramatically between 1997 and 2002 after having dropped from 1992 to 

1997. We cannot divide this time series of capital spending data between 

possessions corporations and other forms of business; however, figure 36 

shows that most of the spending increase was in the pharmaceutical 

industry, which was the source of about two-thirds of total possessions 

corporations profits in 1997. Consequently, it appears that any overall 

decline in possessions corporations’ capital spending that may have 

occurred since 1997 must have been more than offset by the investment of 

other businesses. 

10These differences can be seen by comparing the data in tables 15 and 16 in app. IV.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 97 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 36: Capital Expenditures in Puerto Rico’s Manufacturing Sector, by Industry, 

1987–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

The tax data for our 77 large corporate groups show that the $12.1 billion 

decline in the total assets of the possessions corporations in these groups 

between 1997 and 2001 was largely offset by an increase of at least $9.4 

billion in the total assets of affiliated corporations operating in Puerto Rico 

(see table 15 in app. IV). The decline in assets may have been more than 

fully offset, depending on the growth in the Puerto Rican assets of the 

CFCs that we were not able to include in our estimates.11 However, as was 

the case with income and value added, there were significant differences 

across industries behind the trends for the manufacturing sector as a 

11That increase is based on a lower-bound estimate for CFCs. We did not attempt to estimate 

the Puerto Rican assets of any multinational CFCs for which we did not have Puerto Rican 

tax returns because we considered the relationship between assets and taxes paid to be 

weaker than the relationships between income and taxes paid that we had used to estimate 

the Puerto Rican income of these CFCs. 

Constant 2005 dollars in billions

Years

All other manufacturing

Pharmaceuticals

Source: GAO analysis of published data from the 2002 Economic Census of Island Areas and the

Economic Census of Outlying Areas for 1987,1992, and 1997.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 98 GAO-06-541 Puerto Rican Fiscal and Economic Trends

whole. The decline in assets of possessions corporations in the chemical 

and medical equipment industries between 1997 and 2001 was more than 

offset by the increased assets of their affiliates even if we use just our 

lower-bound estimates for CFCs. In comparison, a little over half of the 

decline in possessions corporations’ assets in the computer, electronics, 

and electrical equipment industries between 1997 and 2001 was offset by 

the growth in affiliated CFCs’ assets. (See tables 16 and 17 in app. IV.)

The economic census data on employment in Puerto Rico’s manufacturing 

sector in figure 37 shows that the decline in employment by possessions 

corporations between 1997 and 2002 was not as drastic as the declines in 

their profits or value added over that period (shown previously in figs. 33 

and 34); however, there was no offsetting increase in overall employment 

by other types of manufacturing firms. Figure 38, which decomposes the 

last two columns of figure 37 into the chemical industry and all other 

industries, shows that employment by possessions corporations in the 

chemical industry did, in fact, fall sharply between 1997 and 2002, but other 

types of businesses in the industry more than made up for that decline. In 

the remaining industries as a whole, there was a smaller percentage 

decrease in employment by possessions corporations but there was also a 

decrease, rather than an offsetting increase, in the employment by other 

types of businesses. The chemical industry is much less important in terms 

of overall employment in manufacturing than it is in terms of value added. 

For this reason the continued strength of that industry was not enough to 

prevent an overall decline in manufacturing employment.
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 99 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 37: Employment in Possessions Corporations and Other Types of Employers

in Manufacturing in Puerto Rico, 1987–2002

Number of employees

Years

All other

Possessions corporations

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the 2002

Economic Census of Island Areas provided by the U.S. Census Bureau.

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

1987 1992 1997 2002

Industry classifications

changed from SIC to NAICS
Chapter 4

Much Possessions Corporation Activity Has 

Shifted to Affiliated Corporations

Page 100 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 38: Employment in Possessions Corporations and Other Types of Employers

in the Chemical Industry and All Other Manufacturing Industries in Puerto Rico, 

1997–2002

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Number of employees

Industry and year

All other types of businesses

Possessions corporations

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

All other

industries

2002

All other

industries

1997

Chemicals

2002

Chemicals

1997

Industry classifications

changed from SIC to NAICS

Source: GAO analysis of IRS data, published data from the Economic Census of Outlying Areas for 1997,

published data from the 2002 Economic Census of Island Areas, and custom tabulations from the 2002

Economic Census of Island Areas provided by the U.S. Census Bureau.
Page 101 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors Chapte5r

U.S.-owned businesses accounted for at least 71 percent of value added and 

at least 54 percent of employment in Puerto Rico’s manufacturing sector in 

2002. CFCs produced most of this value added but possessions 

corporations still accounted for most of the employment by U.S. firms. The 

CFCs are particularly important in the pharmaceutical industry and much 

less so in other manufacturing industries. U.S. corporations appear to 

account for less than 25 percent of employment in Puerto Rico’s wholesale 

and retail trade sectors, where local corporations are the most important 

employers. Similarly, U.S.-owned corporations are not the majority 

employers in any of the large Puerto Rican service industries for which 

data are available.1

U.S. CFCs Have 

Become the Most 

Important Type of 

Business Entity in 

Puerto Rico’s 

Manufacturing Sector 

in Terms of Value 

Added but Not in 

Terms of Employment

As of 2002, U.S. CFCs accounted for 42 percent of value added in Puerto 

Rico’s manufacturing sector—a larger share than that of any other type of 

business entity (see fig. 39). Possessions corporations had the next largest 

share of value added with 27 percent, and other U.S. corporations 

accounted for 2 percent of the total. Together, these three types of 

businesses produced at least 71 percent of total manufacturing value 

added. A small number of U.S.-owned or U.S.-incorporated businesses may 

be included in the category “corporations of type unknown,” but we believe 

that most of the data for that category (in all of the figures in this chapter) 

are attributable to corporations that are not incorporated in the United 

States and are not CFCs.2

1

These findings are based on a special research project that we completed with the 

cooperation of Census and IRS. App. III includes a description of our methodology and 

tables in app. V provide as much detail on the results of this project as Census and IRS 

disclosure rules permit.

2

The corporations in that category include only those for which IRS had no record of any 

requirement for them to file as U.S. corporations. The category also includes a very small 

number of foreign-owned corporations that we could not report on separately due to Census 

nondisclosure rules; it may also include a very small number of CFCs for which we could 

not determine a place of incorporation. See app. III for more detail on our criteria for 

placing businesses into each of our categories.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 102 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 39: Distribution of Value Added for All Puerto Rican Manufacturing by Type of 

Business Entity, 2002

Note: Value-added figures for sole proprietors round to 0 percent.

Possessions corporations remained the largest single type of employer, 

with 31 percent of the sector’s total employment (see fig. 40). Despite their 

large share of manufacturing value added, CFCs had a relatively small 

share—14 percent—of the sector’s total employment, which resulted in the 

extraordinarily high ratios of value added per employee that we discussed 

earlier. In contrast, other U.S. corporations and corporations incorporated 

in Puerto Rico had significantly larger shares of total employment than they 

did of value added.

5%

2%

7%

8%

9%

27% 15%

27%

CFCs incorporated

outside of Puerto Rico

CFCs incorporated

in Puerto Rico

All other employers

Pass-through

entities

0%

Sole proprietors

Other U.S. corporations

Possessions corporations

Other corporations

incorporated in

Puerto Rico

Corporations of

type unknown

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 103 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 40: Distribution of Employment for All Puerto Rican Manufacturing by Type of 

Business Entity, 2002

A little less than two-thirds of the CFCs’ value added and half of their 

employment is attributable to CFCs incorporated outside of Puerto Rico. 

This distribution of value added is similar to the estimated distribution of 

gross profit between the two types of CFCs, based on the tax data for our 

77 large corporate groups for 2001. The estimates presented in figure 41 are 

based on our tax ratio approach for attributing portions of the income of 

multilocation CFCs to Puerto Rico. The estimates indicate that 70 percent 

of the gross profit and 73 percent of net income that CFCs earned in Puerto 

Rico in 2001 were earned by CFCs incorporated outside of Puerto Rico. 

Using the tax data, we estimate that more than three-quarters of the total 

gross and net income earned by the CFCs incorporated outside of Puerto 

Rico in 2001 is attributable to CFCs incorporated in the Cayman Islands, 

Ireland, the Netherlands, and the U.S. Virgin Islands.

2%

3%

7%

6%

7%

9%

12%

31%

23%

CFCs incorporated

outside of Puerto Rico

CFCs incorporated

in Puerto Rico

All other employers

Pass-through

entities

Sole proprietors

Other U.S. corporations

Possessions corporations

Other corporations

incorporated in

Puerto Rico

Corporations of

type unknown

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 104 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 41: Distribution of Income in 2001 between CFCs Incorporated in Puerto Rico and CFCs Incorporated Elsewhere

A comparison of figures 42 and 43 shows that the value added of CFCs in 

2002 was concentrated in the pharmaceutical industry. These firms 

accounted for over half of the value added in that industry, or almost three 

times as much as the value added of possessions corporations. In contrast, 

CFCs accounted for only 13 percent of the value added in all of the 

remaining manufacturing sectors, where possessions corporations still 

dominated with a 48 percent share. At this more specific industry level of 

data, Census nondisclosure rules prevent us from providing as much detail 

about other forms of businesses. We needed to add pass-through entities 

into the “all other and unknown” category. However, from table 20 in 

appendix V, we do know that between approximately 80 percent and 90 

percent of the employees of these entities were concentrated in two 

industries—pharmaceuticals and medical equipment—and that between 25 

percent and 63 percent of these employees were in each of these industries. 

If the value added of these entities was distributed across industries in 

approximately the same manner as their employment, then pass-through 

entities would have accounted for between 3 percent and 7 percent of value 

added in pharmaceuticals.

27%

73%

30%

70%

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Gross profits Net income

CFCs incorporated

in Puerto Rico

CFCs incorporated

elsewhere

CFCs incorporated

in Puerto Rico

CFCs incorporated

elsewhere
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 105 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 42: Value Added in the Pharmaceutical Industry by Type of Business Entity, 

2002

7%

20%

19%

20%

33%

Other corporations

incorporated

in Puerto Rico

CFCs incorporated

in Puerto Rico

CFCs incorporated

outside of Puerto Rico

Other U.S. corporations

1%

Possessions corporations

All other unknown

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 106 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 43: Value Added in Manufacturing, Excluding Pharmaceuticals, by Type of 

Business Entity, 2002

Data in table 20 of appendix V show that possessions corporations and 

CFCs were approximately equal in importance in terms of employment in 

the pharmaceutical industry in 2002 and, together, they accounted for 61 

percent of the industry’s employment. The data also show that possessions 

accounted for a little over a quarter of total employment in all other 

manufacturing industries, while CFCs accounted for only 9 percent.

The Role of U.S. 

Corporations Is Much 

Smaller in Puerto 

Rico’s Wholesale and 

Retail Trade Than in 

Manufacturing

Corporations that were U.S. CFCs and businesses incorporated in the 

United States accounted for less than a quarter of total employment in the 

Puerto Rican wholesale trade sector and, as figure 44 shows, about half of 

their employment was in corporations other than CFCs or possessions 

corporations. Corporations in the unknown category, which we believe to 

be largely ones that are not incorporated in the United States or owned by 

U.S. parent corporations were by far the largest employers in the wholesale 

trade in 2002, as shown in figure 44. Figure 45 indicates that this 

employment distribution was similar for the retail trade sector. The 

primary difference between the two sectors is that possessions 

corporations played no role at all in retail trade and sole proprietors played 

a more important role in that sector than in wholesale trade. The 

4%

6%

9%

11%

22%

48%

Other corporations

incorporated

in Puerto Rico

CFCs incorporated

outside of Puerto Rico

CFCs incorporated

in Puerto Rico

All other and unknown

Possessions corporations

Other U.S. corporations

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 107 GAO-06-541 Puerto Rican Fiscal and Economic Trends

distributions of payroll across entities in these two sectors largely mirrors 

the distributions of employment (see table 17 in app. V).

Figure 44: Share of Employment in Wholesale Trade in Puerto Rico by Type of 

Business Entity, 2002

Note: Sole proprietors and partnerships could not be reported because of disclosure constraints. 

Therefore, they are captured in the “all other employers” category.

6.6%

7.7%

11.6%

63.9%

4.9%

Possessions corporations

Other corporations

incorporated

in Puerto Rico

CFCs

5.3%

All other employers

Corporations of type unknown

Other U.S. corporations

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 108 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 45: Share of Employment in Retail Trade in Puerto Rico by Type of Business

Entity, 2002

Neither Possessions 

Corporations nor CFCs 

Were Significant 

Employers in 2002 in 

Most Puerto Rican 

Service Industries for 

Which Data Are 

Available

In general, possessions corporations and CFCs played minor roles as 

employers in Puerto Rico’s service sector. The 2002 Economic Census of 

Island Areas compiled data for 11 service industries, as well as the mining, 

utilities, and transportation and warehousing sectors in Puerto Rico. Table 

7 shows the distribution of employment across types of businesses for the 

six largest services (in terms of employment) covered by the census. 

Appendix V tables 25–27 show the distribution of employment, sales, and 

payroll, for all 11 service industries and the three other sectors.

CFCs accounted for 32.7 percent of employment in the information 

services industry (which includes telecommunications, broadcasting, 

publishing, motion pictures, and Internet services), but for no more than 

5.1 percent in any of the other five large services. Possessions corporations 

accounted for 10 percent of employment in the accommodations industry 

but for no more than 2.4 percent in any of the other large services. Other 

U.S. corporations accounted for between 10 percent and 20 percent of 

employment in each of the six services. Most of the remaining employment 

in the large service industry is attributable to local corporations (in the type 

unknown group) and sole proprietors. The category “all other employers,” 

7.0%

9.5%

10.6%

12.1%

60.5%

Partnerships

Sole proprietors

All other employers

0.3%

CFCs

Corporations of type unknown

Other U.S. corporations

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas

provided by the U.S. Census Bureau.
Chapter 5

U.S. Businesses Dominated Puerto Rican 

Manufacturing in 2002 but Played Smaller 

Roles in Other Sectors

Page 109 GAO-06-541 Puerto Rican Fiscal and Economic Trends

which includes nonprofit entities, accounts for up to 22 percent of total 

employment in healthcare services, which is the largest service industry.

Table 7: Distribution of Employment by Business Entity Type for the Six Largest Services Included in the 2002 Economic Census

of Puerto Rico

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Note: We are unable to report specific figures on “corporations of type unknown” or “sole proprietors” 

due to disclosure contraints.

Type of business entity

Healthcare 

services Accommodations

Administrative 

support services Finance

Professional 

services Information

Total employment number 

All employers 68,338 63,810 61,703 36,059 26,197 16,696 

Share of employment (percent)

Possessions 

corporations 0.4–0.8 10.0 0.2–0.4 0.1–0.3 2.1 2.4

Other U.S. corporations 11.3 17.4 15.4 10.9 20.2 11.0

U.S. CFCs 3.3 0.4–0.8 5.1 5.1 3.4 32.7

Other corporations 

incorporated in Puerto 

Rico 0.1 (D) 1.0 3.5.2 3.4 10.9

Corporations of type 

unknown (D) (D) (D) (D) (D) (D)

Sole proprietors (D) (D) (D) (D) (D) (D)

Partnerships/passthrough entities 1.4–1.8 6.8 1.5–2.4 0.3–1.0 11.2 1.6–1.7

All other employers 33.9–38 0.2–0.3 10.6–11.5 10.6–11.5 4.3–5.6 0.6
Page 110 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income Chapte6r

The taxes paid to all levels of government (federal, Commonwealth, and 

local) in Puerto Rico in 2002 were $3,071 per capita—considerably less 

than the per capita taxes of $9,426 paid in the states. However, the 

combined taxes paid by Puerto Rico residents amounted to 28 percent of 

their personal income, which was close to the 30 percent figure in the 

states. Puerto Rico’s outstanding government debt in 2002 was much higher 

than that of state and local governments as a share of personal income, 

partly because the Commonwealth government has a wider range of 

responsibilities.

Taxes Paid Per Capita 

in Puerto Rico Are 

Lower Than Those in 

the States but the 

Taxes Are about the 

Same Share of 

Personal Income in 

Both Places

The amount of taxes that Puerto Rico residents paid per capita in fiscal 

year 2002 ($3,071) was about one-third of the amount paid by residents of 

the states ($9,426) (see fig. 46).1

 The mix of the taxes was also quite 

different. While nearly 60 percent ($5,619) of the taxes paid by residents of 

the states were federal taxes, only about 25 percent ($760) of the total 

taxes paid by Puerto Rico residents were federal taxes because those 

residents generally are not subject to federal income tax on the income 

they earn in Puerto Rico. Data on federal taxes paid in the other insular 

areas are not available. Taxes paid by residents of the other insular areas to 

their own governments in 2002 amounted to $2,451 per capita—slightly 

higher than the $2,310 per capita that residents of Puerto Rico paid to the 

Commonwealth and municipal governments. The location where a tax is 

paid is not necessarily the same location as where the economic burden of 

the tax falls. The data we present in this chapter pertain to the former.2

Comparing the taxes Puerto Rico residents paid to the average of the five 

states whose residents paid the least total taxes, we found that Puerto Rico 

residents paid about 54 percent of the amount paid by these state residents

1

We use the term “taxes” as shorthand to cover both taxes and some nontax revenues, such 

as licenses and lotteries, that are collected by state and local government. These nontax 

revenues constitute a relatively small share of the total revenues reported in this chapter 

and they are included, along with other tax revenues, in the “other” category in figs. 48 and 

49. 

2

We exclude federal corporate income tax payments from our comparisons because the 

available data assign all of the tax that a corporation pays to the jurisdiction where it files its 

federal return. In many cases, much of the income on which a corporation is taxed is earned 

outside of the jurisdiction from which it files its return.
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 111 GAO-06-541 Puerto Rican Fiscal and Economic Trends

($5,713).3 The average percentage of taxes paid in these same five states 

that were federal taxes was nearly 47 percent ($2,705), still nearly double 

the percentage for Puerto Rico. The average per capita amount of taxes 

paid in the five highest tax states was $15,491—five times the per capita tax 

in Puerto Rico.4

Figure 46: Per Capita Taxes Paid in the United States and Insular Areas, Fiscal Year 

2002

Note: Data on federal taxes paid in the other insular areas are not available.

Taxes as a share of personal income are about the same in Puerto Rico and 

the states, which is not surprising because Puerto Rico’s income per capita 

3

The five states whose residents paid the least total taxes were Montana, South Carolina, 

Alabama, West Virginia, and Mississippi.

4

The five highest tax states were the District of Columbia, Minnesota, Delaware, 

Connecticut, and New Jersey.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Other insular

areas

Average for

low five

states

Average for

high five

states

Puerto Rico States

Dollars per capita

Jurisdictions

Federal taxes

Commonwealth, state, and local taxes

Source: GAO analysis of IRS, Census, and Insular Area Treasury Department data.
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 112 GAO-06-541 Puerto Rican Fiscal and Economic Trends

is so much lower. Taxes paid in Puerto Rico amounted to 28 percent of the 

Commonwealth’s personal income, while those paid in the states amounted 

to 30 percent of aggregate state personal income. Taxes in the five lowesttax states were an average of 23 percent of the states’ aggregate personal 

income, while those in the five highest-tax states averaged 39 percent. (See 

table 28 in app. VI for additional detail.)

Figure 47: Taxes Paid as a Share of Personal Income in the United States and Insular 

Areas, Fiscal Year 2002

Note: Data on personal income in the other insular areas are not available.

0

5

10

15

20

25

30

35

40

Average for

low five

states

Average for

high five

states

Puerto Rico States

Percentage

Jurisdictions

Federal taxes

Commonwealth, state, and local taxes

Source: GAO analysis of IRS, Census, and Insular Area Treasury Department data.
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 113 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Income and 

Employment Taxes 

Account for about 

Two-thirds of the Taxes 

Paid in Both Puerto 

Rico and the States, 

but the Allocation of 

Those Taxes by Level 

of Government Differs 

between the Two 

Locations

As shown in figure 48, about 75 percent of the taxes paid in Puerto Rico are 

levied by the Commonwealth and municipal governments.5

 The property 

tax and gross receipts tax imposed by the municipal government accounted 

for a little over 17 percent of taxes paid with the remainder going to the 

Commonwealth government.6

 Commonwealth income taxes accounted for 

41 percent of total taxes with slightly more than half of that being paid by 

resident individuals. Sales and excise taxes represented 23 percent of the 

total.

Data available from IRS for Puerto Rico and the states do not separate 

federal individual income tax payments from payments of federal 

employment taxes, such as those for Social Security, Medicare, and 

unemployment compensation; however, most of the tax shown for that 

combined category in figure 48 should be employment taxes because most 

residents of Puerto Rico pay little, if any federal income tax. Even less 

federal estate, gift, or excise tax is paid in Puerto Rico. Federal excise taxes 

on goods manufactured in Puerto Rico and sold in the states are 

transferred to the Commonwealth and more than offset any federal excise 

tax on products consumed there.7

5

The taxes being compared in this section exclude the federal corporate income tax, which 

is difficult to allocate by location.

6

The municipal gross receipts tax is included in the “sales and excise” category.

7

In fig. 48 federal excise taxes are represented as a zero, rather than the net positive amount 

transferred to the Commonwealth.
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 114 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 48: The Composition of Taxes Paid in Puerto Rico, Fiscal Year 2002

Notes: Numbers do not sum because of rounding.

The figures for federal estate and gift taxes round to 0 percent.

In contrast to the case of Puerto Rico, more than half of the taxes paid in 

the states go to the federal government, which provides a larger range of 

services to the states than it does to the Commonwealth. Federal individual 

income and employment taxes accounted for 56 percent of the taxes paid, 

while federal estate, gift, and excise taxes amounted to an additional 3 

percent, resulting in a combined federal share of 59 percent (see fig. 49). 

When the 10 percent of taxes paid in the form of state and local income 

taxes are added to the 56 percent that go to federal individual income and 

employment taxes, the resulting 66 percent share is almost equal to the 67 

percent share in Puerto Rico for this same group of taxes. Of the remaining 

total, state and local property taxes and “other” revenues (including 

lotteries and licenses) account for greater shares of the total taxes paid in 

the state than they do in Puerto Rico, while sales and excise taxes 

represent a smaller share.

0%

75%

26%

Source: GAO analysis of IRS and Puerto Rico Treasury data.

Federal estate and gift

Commonwealth

and municipal

Federal individual income

and employment

Individual income

Corporate income

Nonresident withholding

Property

Sales and excise

Other

21%

15%

5%

6%

23%

4%
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 115 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 49: The Composition of Taxes Paid in the States, Fiscal Year 2002

Puerto Rico’s 

Outstanding 

Government Debt in 

2002 Was Much Higher 

Than That of State and 

Local Governments as 

a Share of Personal 

Income, Partly 

Because the 

Commonwealth 

Government Has a 

Wider Range of 

Responsibilities

The amount of Puerto Rican government-issued debt outstanding as of 

2002 was slightly higher in per capita terms, but much higher as a share of 

personal income, than was state and local government-issued debt. As 

shown in figure 50, the outstanding amount of Puerto Rican government 

debt per capita in 2002 was about $7,580, compared to a national average of 

$5,820 for state and local government-issued debt. The per capita debt of 

the governments of the other insular areas in 2002 was about $5,690. 

Although all of this debt was issued by the respective governments, some 

of it is directed to private use and will be paid back by targeted 

beneficiaries. About 16 percent of Puerto Rico’s government debt fell into

41%

56%

Source: GAO analysis of IRS and Census data.

1% Federal estate and gift

2% Federal excise

Federal individual income and

employment

State and local

Individual income

Corporate income

Property

Sales and excise

Other

9%

1%

10%

12%

9%
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 116 GAO-06-541 Puerto Rican Fiscal and Economic Trends

this “private use” category, compared to about 23 percent for state and 

local government debt.8

Figure 50: Per Capita Government Debt in the United States and Insular Areas, 

Fiscal Year 2002

Note: We did not categorize federal or other insular areas debt into “public use” or “private use.”

8

Puerto Rico’s Government Development Bank provided us detailed information on specific 

Puerto Rican government debt issues and we assigned those issues to the private or public 

use categories in a manner that was consistent with how the U.S. Census of Governments 

categorizes state and local government debt.

0

5,000

10,000

15,000

20,000

25,000

Other insular Federal

areas

State and

local—

low five

states

State and

local—

 high five

states

State and

local—

nationwide

Puerto Rico

Dollars per capita

Jurisdictions

Private use

Public use

Source: GAO analysis of IRS, Census, Puerto Rico Government Development Bank, 

and Insular Area Treasury Department data. 
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 117 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 51: Government Debt as a Share of Personal Income in the United States and 

Insular Areas, Fiscal Year 2002

Note: We did not categorize federal debt into “public use” or “private use.”

0

10

20

30

40

50

60

70

80

Percentage

Jurisdictions

Private use

Public use

Source: GAO analysis of IRS, Census, Puerto Rico Government Development Bank, 

and Insular Area Treasury Department data. 

State and Federal

local—

low five

states

State and

local—

 high five

states

State and

local—

nationwide

Puerto Rico
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 118 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Federal Grants and 

Payments to 

Governments Per 

Capita Are the Same 

for Puerto Rico and the 

States but Direct 

Federal Payments to 

Individuals Per Capita 

Are Significantly Lower 

in Puerto Rico

The states and insular areas receive funds from the federal government in 

the form of grants, direct aid, loans, and insurance and procurement 

payments (see table 8). Federal grants and payments to the Puerto Rican 

government in 2002 amounted to $1,242 per capita, about the same as the 

$1,264 per capita paid to all state and local governments in the states, but 

less than the $1,703 per capita paid to the other insular area governments. 

The $2,057 per capita of direct federal payments to individuals in Puerto 

Rico was well below the $3,648 per capita paid to state residents, but higher 

than the $1,418 per capita paid to residents of the other insular areas.9

 The 

following chapter and appendix VII provide detailed information on the 

amount of spending for specific federal social programs in Puerto Rico, the 

states, and other insular areas and describes similarities and differences in 

the operation of these programs in the various locations. The per capita 

federal payments of $336 for salaries, wages, and procurement in Puerto 

Rico were about 20 percent of payments for those purposes in the states 

and the other insular areas.

9

These payments do not include outlays made to individuals through refundable credits in 

the federal tax code, such as the child tax credit and the earned income tax credit. IRS does 

not report the refundable portion of the child tax credit by state; it does report the 

refundable portion of the earned income tax credit, but it combines the amounts earned in 

Puerto Rico and the other insular areas. For tax year 2001, the per capita amount for those 

areas was $3.1, while the nationwide average amount per capita was $102.8. Generally, 

residents of an insular area cannot claim the earned income tax credit or the child tax 

credit. 
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 119 GAO-06-541 Puerto Rican Fiscal and Economic Trends

(Page is left blank intentionally.)
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 120 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 8: Federal Expenditures in Fiscal Year 2002

Source: GAO analysis of Census data.

a

Data reported are actual cash outlays. Includes transfers of custom duties and excise tax revenues. 

Fiscal activity

Puerto Rico

Dollars

(in thousands) Per capita

Percent of commonwealth personal

income

Nationwide

per capita

Federal expenditures

Grants and payments to 

governmentsa $4,793,333 $1242.1 11.4 $1,263.9

Direct payments 7,939,376 2,057.4 18.6 3,648.3

Salaries/wages 930,078 241.0 2.2 692.0

Procurement 364,652 94.5 0.9 903.5

Loans 1,353,279 350.7 3.2 866.0

Insurance 3,171,069 821.7 7.5 2,358.1
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 121 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The States Insular areas

High five per

capita

Low five per

capita

Nationwide percent of

state personal income

High five percent of

state

personal income

Low five percent of

state personal

income Combined per capita

$2,202.1 $927.5 4.0 9.7 2.7 $1,702.8

4,969.2 3,059.8 11.6 19.1 8.9 1,417.6

2,784.4 352.9 2.2 7.9 1.1 838.7

3,723.8 314.5 2.9 10.8 1.1 893.2

2,146.1 477.9 2.7 7.4 1.6 227.9

13,127.7 346.6 7.5 45.1 1.2 779.3
Chapter 6

Taxes Per Capita in Puerto Rico Are Lower 

Than in the States but Are about the Same 

Share of Income

Page 122 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Some federal funds that Puerto Rico received as grants and direct 

payments were in the form of a rebate on custom duties and a cover over10

of excise taxes collected on rum. These funding sources are not available 

to the states or the District of Columbia, or most of the insular areas except 

for the U.S. Virgin Islands. On a per capita basis the U.S. Virgin Islands 

received a larger rebate payment than Puerto Rico and a larger cover over 

payment than Puerto Rico (see table 9).

Table 9: Federal Custom Duties and Excise Taxes Returned to Puerto Rico in Fiscal Year 2002

Source: GAO analysis of Customs and Alcohol and Tobacco Tax and Trade Bureau data.

Note: n.a. means not applicable.

1026 U.S.C. 7652 provides that federal alcohol excise taxes collected on rum produced in 

Puerto Rico and the U.S. Virgin Islands and imported into the United States, after deducting 

administrative expenses, are “covered over” or paid into the treasuries of Puerto Rico and 

the U.S. Virgin Islands. 

Puerto Rico U.S. Virgin Islands

50 states and the 

District of Columbia

Revenues

(in thousands) Per capita

Revenues

(in thousands) Per capita

Revenues

(in thousands)

(median)

Rebates of customs’ duties $33,635 $8.7 $2,405 $22.1 n.a.

Excise cover over 339,414 87.9 64,936 595.7 n.a.
Page 123 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Chapter 7

The Extent That Federal Social Programs in 

Puerto Rico Mirror Those in the States and 

Other U.S. Insular Areas Varies Chapte7r

Comparison of 

Selected Federal Social 

Programs

Like the states, Puerto Rico and the other U.S. insular areas receive federal 

funds for a variety of social programs—including federal housing 

assistance, education, and health care financing programs—which provide 

assistance to elderly and needy families and individuals. Generally, the 

social programs we examined in these areas targeted similar populations 

and delivered similar services—although Puerto Rico and the other insular 

areas did not always do so through the program as it exists in the states 

(see table 10). For example, in lieu of the Food Stamp Program available in 

the states, which is an entitlement1

 program based on the number of 

participants, Puerto Rico receives a capped block grant that has similar 

eligibility requirements. The major difference between some of the social 

programs we examined in the states versus those in Puerto Rico and the 

other insular areas is how they are funded. For example, where federal 

Medicaid spending is an open-ended entitlement to the states, it is subject 

to a statutory cap and a limited matching rate in Puerto Rico and the other 

insular areas.2

 Some of the social programs and housing programs that we 

examined are available in the states, but are not available in some of the 

insular areas.

1

A government entitlement program provides benefits to all that meet certain eligibility 

criteria.

2

For additional information on the health care financing programs in these areas, see GAO, 

U.S. Insular Areas: Multiple Factors Affect Federal Health Care Funding, GAO-06-75

(Washington, D.C.: Oct. 14, 2005).
Chapter 7

The Extent That Federal Social Programs in 

Puerto Rico Mirror Those in the States and 

Other U.S. Insular Areas Varies

Page 124 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 10: Comparison of Selected Social Programs in the U.S. Insular Areas to Those in the States

Program Program rules in the U.S. insular areas compared to those in the states

Education programs

Individuals with Disabilities Education Act 

(IDEA) Part B

Puerto Rico and the other insular areas receive IDEA funds and must comply with IDEA 

requirements that apply in the states as a condition of funding. 

Title I of the Elementary and Secondary 

Education Act, reauthorized by the No Child 

Left Behind Act of 2001

Title I funds are provided to schools in Puerto Rico and in the other insular areas. 

Schools in these locations are subject to the same requirements as schools in the states.

Food and nutrition programs

Child and Adult Care Food Program Same in the states, Puerto Rico, the U.S. Virgin Islands, and Guam; program does not 

operate in CNMI and American Samoa.

Food Stamp or Nutrition Programs Same in the states, the U.S. Virgin Islands, and Guam; Puerto Rico, American Samoa, 

and CNMI provide assistance similar to the Food Stamp Program through a capped block 

grant; certain eligibility rules for the grant differ. 

National School Lunch Program Same in the states, Puerto Rico, the U.S. Virgin Islands, and Guam; program does not 

operate in CNMI and American Samoa, but funds under capped block grants for nutrition 

programs may be used to provide school meals in these insular areas. 

Special Supplemental Nutrition Program for 

Women, Infants, and Children (SS Nutrition 

for WIC)

Same in the states, Puerto Rico, American Samoa, Guam, and the U.S. Virgin Islands; 

program does not operate in CNMI.

Health care financing and grant programs

Medicare Program eligibility and benefits largely similar between the insular areas and the states; 

however, differences exist regarding the new Part D outpatient prescription drug benefit. 

Medicaid Federal share of expenditures in the insular areas is limited to a 50 percent matching rate 

and federal Medicaid spending for the insular areas is subject to statutory caps. In light of 

federal funding limits, the Centers for Medicare & Medicaid Services (CMS) does not hold 

Puerto Rico and the other insular areas accountable for covering all the mandatory 

Medicaid benefits required of the states. 

State Children’s Health Insurance Program 

(SCHIP)

Federal allotment to Puerto Rico and the other insular areas is based on statutorily set 

proportions versus the population of low-income, uninsured children, as is the case in the 

states. Insular areas receive minimum federal matching contributions that do not apply to 

the states.

Health grants Method used to determine funding amounts varies by grant. Certain grants use the same 

allocation method for the states and the insular areas, while other grants treat some or all 

of the insular areas differently. 

Income assistance programs

Aid to the Aged, Blind, or Disabled (AABD) Supplemental Security Income (SSI), which serves a similar population, exists in the 

states and CNMI, but not in the other insular areas. The other insular areas continue to 

operate their grant programs that existed before SSI was created, specifically AABD for 

Puerto Rico.

Temporary Assistance for Needy Families 

(TANF)

Program provisions generally the same for Puerto Rico, Guam, and the U.S. Virgin 

Islands, but they cannot receive all funding sources available to the states; American 

Samoa and CNMI do not participate. 

Child care programs 
Chapter 7

The Extent That Federal Social Programs in 

Puerto Rico Mirror Those in the States and 

Other U.S. Insular Areas Varies

Page 125 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Source: GAO analysis of U.S. federal social programs.

a

Information was not readily available for CNMI and American Samoa.

More detailed information on how each of the programs is applied in the 

insular areas and the states can be found in appendix VII. 

Child Care and Development Fund (CCDF) Program provisions generally the same for the states, Puerto Rico, and the insular areas, 

but the insular areas cannot receive all funding sources available to the states.

Foster Care and Adoption Assistance Funds Puerto Rico participates in these programs and receives funds, which are limited by the 

federal funding cap, set by the 1996 federal welfare law. Other insular areas do not 

participate in these programs.

Housing programs

Public Housing Funding formula the same in the states, Puerto Rico, the U.S. Virgin Islands, and Guam.a

HOPE VI Same in the states and insular areas. 

Housing Choice Vouchers Same in the states and insular areas.

Community Development Block Grant Same in the states and Puerto Rico; other insular areas receive an amount determined 

by the U.S. Department of Housing and Urban Development (HUD) based on population 

and performance in previous years.

HOME Investment Partnerships Program Puerto Rico subject to a funding cap that does not apply to the other states; the initial 

HOME allocation amount for each of the insular areas is based on its population and 

occupied rental units compared to all the insular areas 

Project-based Section 8 Program Same in the states and insular areas. 

Section 203 (b) Single Family Mortgage 

Insurance Program

Same in the contiguous 48 States and Puerto Rico; different mortgage insurance limits 

for Guam, the U.S. Virgin Islands, Alaska, and Hawaii.a

(Continued From Previous Page)

Program Program rules in the U.S. insular areas compared to those in the states
Page 126 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix I

Methodology for Allocating the Assets and Apendxies

Liabilities of Depository Banks by Geographic 

Location ApendxiI

In order to identify where the assets held in the Puerto Rican banking 

system are invested and where the owners of the banks’ liabilities reside, 

we analyzed institution-specific data that the Office of the Commissioner of 

Financial Institutions (OCFI) collects for oversight purposes. Banks and 

certain other financial institutions in Puerto Rico are required to report 

detailed information regarding their assets, liabilities, and capital to OCFI 

through a computerized “CALL report” data system.1

 In addition to a basic 

balance sheet, the institutions are required to file various supporting 

schedules and addenda. In the case of depository banks (Puerto Rican, 

U.S., and foreign commercial banks, plus Puerto Rican government banks) 

some of the schedules and addenda ask the institutions to identify the 

geographic location of assets they own; others ask for the residency of the 

owners of the banks’ liabilities. We obtained a copy of the computer file 

OCFI has compiled containing all of the detailed CALL report data 

submitted by each of these institutions for the years 1997 through 2004. The 

data, in combination with other information, allowed us to allocate 

substantial portions of the total assets and liabilities of depository banks 

between Puerto Rico and elsewhere. (There were no reporting 

requirements that enabled us to allocate the banks’ capital by residency of 

shareholders.) In 2004 the depository banks accounted for about two-thirds 

of the assets held in financial institutions supervised by OCFI. Given the 

lack of location-specific data for the other financial institutions, we simply 

report their total assets to indicate their size in relation to the depository 

banks. 

Table 11 identifies the lines from the various schedules that we used to 

allocate specific balance sheet items by geographic location. We sent a 

draft version of this allocation methodology to OFCI for their review and 

incorporated several corrections that they identified for us. We ultimately 

allocated each dollar from the balance sheets into one of three categories: 

U.S. and foreign, Puerto Rican, or unknown. The last category covers all 

amounts that we could not identify as belonging to either of the first two 

categories. The CALL report data did not provide a means for allocating 

most loans and leases. For this line item we assume that 95 percent of loans 

and leases are made to borrowers in Puerto Rico, based on the fact that 

several financial experts from Puerto Rico all agreed that at least 95 

percent of the loans were made locally, even though some of the larger 

banks have begun to enter the U.S. market.

1

The system contains no data for insurance companies, credit unions, mutual funds, or 

pension funds.
Appendix I

Methodology for Allocating the Assets and 

Liabilities of Depository Banks by 

Geographic Location

Page 127 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 11: Allocation of Balance Sheet Items by Geographic Location

Source: GAO.

OCFI conducts a set of quality reviews on the CALL report data that the 

financial institutions submit. We undertook our own consistency checks on 

the data relevant to our allocation analysis. We detected some differences 

between the total amounts reported on the balance sheet and the 

summations of amounts listed in the addenda that should have totaled to 

the balance sheet amounts. Some differences were extremely small, which 

we attributed to inconsequential reporting errors. However, we identified 

Sheet line item Sources identified for portions that could be allocated 

ASSETS

Cash

Non-interest-bearing 

balances 

U.S. and Foreign combined identified: Addendum-RC-Balance sheet (CALL report) line 1b. Puerto Rican 

identified: Addendum-RC-Balance sheet (CALL report) line 1a.

Interest-bearing 

balances

U.S. and Foreign combined identified: Addendum-RC-Balance sheet (CALL report) line 2b. Puerto Rican 

identified: Addendum-RC-Balance sheet (CALL report) line 2a.

Securities U.S. identified: Schedule RC-B Securities lines 1, 2a, 2b, 4a(1), 4a(2), 4b(1), and 4b(2). Foreign identified:

RC-B Securities line 6b. U.S. and Puerto Rican combined identified: RC-B Securities lines 3 and 6a.

Federal funds sold and 

securities purchased

U.S. and Foreign combined identified: Addendum-RC-Balance sheet (CALL report) lines 3a and 4a. Puerto 

Rican identified: Addendum-RC-Balance sheet (CALL report) lines 3b and 4b.

Loans and leases Allocated 95 percent to Puerto Rico and 5 percent to the U.S. and Foreign categories based on the consensus 

of experts that we interviewed.

Trading assets No ability to allocate to any source. 

Other assets No ability to allocate to any source.

LIABILITIES

Deposits

Private Puerto Rican identified: Addendum-RC-Balance sheet lines 17a, 17b. U.S. and Foreign identified: line17d.

936 deposits U.S. identified: Addendum-RC-Balance sheet lines 17c.

States, political 

divisions

U.S. identified: Addendum-RC-Balance sheet (CALL report) lines 18b, 18c, 18d. Puerto Rican identified:

Addendum-RC-Balance sheet (CALL report) lines 18a.

Commercial banks U.S. identified: Addendum-RC-Balance sheet (CALL report) lines 20b(1) and 20b(2). Foreign identified:

Addendum-RC-Balance sheet (CALL report) lines 20a(1) and 20a(2).

Foreign/government 

banks

U.S. identified: Schedule RC-E-Deposit liabilities line 2. Foreign identified: Schedule RC-E-Deposit liabilities 

lines 5 and 6. 

Total debt Puerto Rican identified: Addendum-RC-Balance sheet (CALL report) lines 6a, 7a, and 8a. U.S. identified: 

Addendum-RC-Balance sheet (CALL report) line 7c. U.S. and Foreign combined identified: Addendum-RCBalance sheet (CALL report) lines 6b, 7b, and 8b. 

Trading liabilities No ability to allocate to any source. 

Other liabilities U.S. and Foreign identified: Addendum-RC-Balance sheet (CALL report) line 9b. Puerto Rican identified: 

Addendum-RC-Balance sheet (CALL report) line 9a.
Appendix I

Methodology for Allocating the Assets and 

Liabilities of Depository Banks by 

Geographic Location

Page 128 GAO-06-541 Puerto Rican Fiscal and Economic Trends

three types of significant discrepancies. The first type of discrepancy was 

due to financial institutions reporting a positive amount for a balance sheet 

item but not providing the geographic detail that should have been reported 

in an addendum. The second type of discrepancy resulted from financial 

institutions listing more in the addendum than in the balance sheet for a 

given line item. In these cases there was always a specific amount that 

appeared to be either double-counted in the addendum or not reported in 

the balance sheet amount. The last type of discrepancy comprised cases of 

financial institutions that reported either too little or too much in the 

addendum for corresponding balance sheet items but with no obvious 

pattern or explanation.

We provided experts in OCFI a spreadsheet with the specific cases of 

discrepancies for each type of discrepancy and each affected balance sheet 

line item along with a detailed explanation and suggested resolutions 

where we could offer any. Based on OCFI’s responses, we adjusted our 

unknown group to include discrepancy amounts due to financial 

institutions reporting zero on the addendum. Officials from the 

Commissioner’s office considered the balance sheet values to be more 

accurate than the addendum breakouts so in the second and third types of 

discrepancies we were unable to make any corrections to adjust for these 

differences. In our consultation with Puerto Rican officials we further 

determined that in early years the financial institutions were not required 

to fill out the addendum and that the remaining differences result largely 

from reporting discrepancies at the institution level.

Table 12 provides a summary of the absolute value of the unexplained 

discrepancies as a percentage of the balance sheet line item for selected 

items. For those cases where the unexplained discrepancies exceeded 5 

percent of the total value for a line item in a given year we decided that our 

allocation results were too uncertain to be presented and we simply show 

the totals for those items in our figures.
Appendix I

Methodology for Allocating the Assets and 

Liabilities of Depository Banks by 

Geographic Location

Page 129 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 12: Percent of Discrepancies by Line Item (percent)

Source: GAO.

Year

Total 

assets

Loans and 

leases

Total 

liabilities Deposits Total debt

2004 0.3 0.5 4.6 0.8 0.3

2003 1.5 2.2 2.0 0.8 1.5

2002 1.0 2.0 4.2 0.2 1.0

2001 2.6 3.5 2.6 2.4 2.6

2000 1.2 0.7 4.2 5.7 1.2

1999 1.8 0.9 3.1 2.5 1.8

1998 0.6 0.5 5.0 2.4 0.6

1997 2.5 1.0 17.7 15.0 2.5

1996 0.4 0.7 16.5 5.5 0.4

1995 0.4 0.7 10.1 1.3 0.4
Page 130 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows ApendxiI

The following series of figures present additional information on the 

sources and uses of funds for financial institutions operating in Puerto 

Rico.

Figure 52: Puerto Rico’s Depository Institutions’ Deposits, 1995–2004

Notes: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

In 1997 and 2000, the sum of Puerto Rican, U.S., and foreign deposits from the addenda exceeded the 

balance sheet totals by $4,811 and $86 million, respectively. 

0

10,000

20,000

30,000

40,000

50,000

60,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Unknown (U.S. or foreign)

U.S. and foreign

Puerto Rico

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions data. 

Internal inconsistencies prevent reliable allocation between U.S. and foreign, unknown, and

Puerto Rico in years 1996, 1997, and 2000.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 131 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 53: Puerto Rico’s Depository Institutions’ Debt, 1995–2004

Notes: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

In 2004, the sum of Puerto Rican, U.S., and foreign debt from the addenda exceeded the balance 

sheet totals by $823 million.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Unknown

Puerto Rico

U.S. and foreign

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions data. 

Internal inconsistencies prevent relaiable allocation between U. S. and foreign, unknown, and

Puerto Rico in years 1995−1998 and 2002.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 132 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 54: Exempt Deposits of Possessions Corporations and Brokered Deposits in 

Puerto Rican Banks, 1997–2004

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

0

2

4

6

8

10

12

14

Constant 2004 dollars in millions

Source: GAO analysis of data provided by the Commissioner of Financial Institutions, Commonwealth of Puerto Rico.

Year

Exempt investments

Brokered deposits

2004-March

June

S

S

ept

Dec

ept

Dec

2003-March

Dec

2002-March

June

Dec

2001-March

June

Sept

June

Sept

2000-March

June

S

Dec

ept

Dec

1999-March

Sept

1998-March

June

Dec

June

Sept

1997-March
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 133 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 55: Puerto Rico’s Depository Institutions’ Securities Investments, 1995–2004

Notes: No securities were clearly identified as being located in Puerto Rico. 

Known investment in foreign securities make up less than 1 percent of the total for every year between 

1995 and 2004. 

Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Unknown

U.S. and foreign

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions data.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 134 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 56: Puerto Rico’s Depository Institutions’ Loans and Leases, 1995–2004

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

In chapter 3 of this report we provided information on the physical location 

of the assets and liabilities of depository institutions operating in Puerto 

Rico. Although we are unable to report this kind of detail for the other 

types of financial institutions in Puerto Rico, in figure 57 we are able to 

present data from OCIF on selected other types of institutions. Table 14 

presents summary descriptions of the sources and uses of funds for these 

institutions, as explained to us by several private sector financial experts in 

Puerto Rico and confirmed by OCIF. The figure and table do not include 

international banking entities, which OCIF also oversees, because those 

entities do not form part of the local capital market.

0

10,000

20,000

30,000

40,000

50,000

60,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Source: GAO analysis of Puerto Rico's Office of the Commissioner of Financial Institutions data. 

Year
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 135 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 57: Assets of Selected Financial Institutions in Puerto Rico, 1995–2004 

Notes: Figures were adjusted for inflation using Puerto Rico's gross product deflator.

No data were available for investment or venture capital prior to 1997; no data were available for 

securities brokers prior to 2002.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Real dollars in millions

Year

Credit unions

Securities brokers

Venture capital

Investment

Small loan

Mortgage

Leasing

Financing

Source: GAO analysis of data from Puerto Rico's Office of the Commissioner of Financial Institutions.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 136 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 13: The Source and Use of Funds for Selected Financial Institutions in Puerto Rico

Source: GAO.

Type of Institution Description of Source and Use of Funds

Credit unions They obtain and use their funds in the local (Puerto Rican) market.

Broker/dealers The broker/dealers represented in fig. 57 obtain all but a small portion of their funds locally and invest 

most of those funds locally.

Small-loan companies These companies obtain their funds in the U.S. market and lend to subprime borrowers in Puerto Rico.

Mortgage banks On the funding side the Puerto Rican mortgage market is indistinguishable from the U.S. market. Most 

funds are lent locally.

Investment companies Only Puerto Rican residents can invest in these companies. Most of their funds are invested in Puerto 

Rico with a minor portion going to the United States.

Leasing companies These companies are subsidiaries of banks and their funding is the same as for their parent banks.

Financing companies These companies, which operate in the car loan market, obtain their funds in the United States and 

lend locally.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 137 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 58: Real Debt Issued by the Government of Puerto Rico, but Payable from 

Private or Federal Funds, or Asset Sales, by Market of Purchaser, 1995–2005

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator. 

Amount outstanding (dollars in billions)

Source: GAO analysis of Government Development Bank of Puerto Rico data.

Fiscal year ending June 30

Local

U.S.

0

2

4

6

8

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 138 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 59: Real Debt Issued and Payable by the Government of Puerto Rico, by 

Market of Purchaser, 1995–2005

Note: Figures were adjusted for inflation using Puerto Rico’s gross product deflator.

A Comparison of Rates 

of Return for 

Possessions 

Corporations and 

Controlled Foreign 

Corporations (CFC) in 

Puerto Rico’s Chemical 

Industry

In contrast to the various U.S. Census Bureau (Census) data we have 

presented that show a sharp increase in value added per employee as 

pharmaceuticals production was shifted from possessions corporations to 

CFCs, the tax data for our large corporate groups do not show a clear trend 

in the rates of return on assets for these two types of corporations. We 

could not exactly replicate the comparison we made with the Census data 

with our tax data because we lacked employment data for our large groups 

of corporations. Instead, we compared the ratios of gross profit (the closest 

tax data equivalent of value added) to total assets. The results presented in 

figure 60 shows that the ratios for CFCs in the chemical industry were 

significantly higher than those for possessions corporations in the same 

industry in both 1997 and 1999, but the ratios were very close in

Amount outstanding (dollars in billions)

Source: GAO analysis of Government Development Bank of Puerto Rico data.

Fiscal year ending June 30

Local

U.S.

0

5

10

15

20

25

30

35

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 139 GAO-06-541 Puerto Rican Fiscal and Economic Trends

2001.1 We also compared the ratio of net income over total assets and found 

a similar pattern, except for the fact that the net return for possessions 

corporations in 2001 was slightly higher than that for CFCs.

Figure 60: Rates of Return on Total Assets for Possessions Corporations and CFCs

in the Chemical Industry, Puerto Rico, 1997, 1999, 2001

In addition, we compared the gross and net operating rates of return of 

possessions corporations and CFCs in the chemical industry and found that 

neither type of corporation dominated the other type consistently across 

the years (see fig. 61). We used the same measure of net operating rate of 

return that Grubert and Slemrod had computed for possessions

1

For the CFC side of the comparison we included only those CFCs for which we had Puerto 

Rican tax returns, or that appeared to have operations only in Puerto Rico.

0

20

40

60

80

100

120

140

1997 1999 2001

Percent

Tax year

Source: GAO analysis of data from IRS.

Gross profits/total assets—possessions corporations

Net income/total assets—possessions corporations

Gross profits/total assets—CFCs

Net income/total assets—CFCs
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 140 GAO-06-541 Puerto Rican Fiscal and Economic Trends

corporations for 1987.2 With one exception (for CFCs in 2001), our net 

return estimates for both types of corporations for 1997, 1999, and 2001 all 

exceeded 200 percent and were significantly higher than Grubert and 

Slemrod’s estimate of 138.6 percent for possessions corporations in the 

pharmaceutical industry in 1987. 

Figure 61: Rates of Return on Operating Assets for Possessions Corporations and 

CFCs in the Chemical Industry, Puerto Rico, 1997, 1999, 2001

Possessions corporations fared better relative to CFCs in terms of their 

returns on operating assets, rather than total assets, because the operating 

2

Grubert and Slemrod defined net operating rate of return as the ratio of operating income 

(net income, plus interest paid, and less interest received) over operating assets 

(inventories, plus gross depreciable and depletable assets, and land). We computed a gross 

operating rate of return by substituting gross profits for operating income.

0

50

100

150

200

250

300

350

1997 1999 2001

Percent

Tax year

Source: GAO analysis of data from IRS.

Gross profits/operating assets—possessions corporations

Net operating income/operating assets—possessions corporations

Gross profits/operating assets—CFCs

Net operating income/operating assets—CFCs
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 141 GAO-06-541 Puerto Rican Fiscal and Economic Trends

assets of possessions corporations represented a significantly lower share 

of their total assets than was the case for CFCs. Figure 62 shows that as the 

large corporate groups gradually decreased the size of their possessions 

corporations’ operations in Puerto Rico after 1997, operating assets 

accounted for a progressively smaller share of total assets until 2003, when 

an accumulation of inventories stopped the decline. In 2001, operating 

assets accounted for only 17.7 percent of possessions corporations’ total 

assets in the chemical industry. In contrast, operating assets accounted for 

41.9 percent of the total assets of all of the CFCs in the chemical industy for 

which we had reliable asset information in 2001. Internal Revenue Service 

(IRS) officials with expertise in possessions corporations issues told us 

that the large corporate groups would have an incentive to keep as many of 

the liquid assets of the possessions corporations (everything but land and 

depreciable and depletable assets) within those entities, even as they 

transferred the latter’s fixed assets to CFCs, because a transfer of those 

liquid assets to a foreign corporation could be subject to federal income 

tax.
Appendix II

Additional Information on Puerto Rican 

Economic Trends and Capital Flows

Page 142 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Figure 62: Composition of Assets of the Possessions Corporations of All Large 

Groups, Puerto Rico, 1993–2003

0

10

20

30

40

50

60

70

80

90

100

1993 1995 1997 1999 2001 2003

Percent

Year

Other assets

Investments and other current assets

Cash and accounts receivable

Net intangible assets

Inventories

Land, depreciable and depletable assets

Source: GAO analysis of data from IRS.
Page 143 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix III

Methodology for Analyses of Business 

Activities ApendxiI

Methodology for 

Determining How Economic 

Activity in Puerto Rico is 

Distributed across Types of 

Business Entities

We used a combination of data provided by Census, IRS, and the Puerto 

Rican Department of Treasury to determine how economic activity in 

Puerto Rico is distributed across types of business entities. The multistage 

procedure we followed in cooperation with Census and IRS was as follows:

1. We obtained a database from IRS that contained the employer 

identification numbers (EIN) and names for approximately 50,126 

employers that either (1) operated in Puerto Rico or (2) were 

businesses related to those operating in Puerto Rico. The initial 

population for Census’s surveys of employers for the 2002 Economic 

Census of Puerto Rico was included among these 50,126 employers. 

2. We assigned each EIN to one of 11 groups based on IRS or Puerto Rican 

tax data, using the criteria described below. Ten of the groups 

represented types of businesses. We assigned each group an 

identification letter and did not tell Census the types of businesses that 

they represented. We labeled the 11th group “unknown” and assigned all 

of the EINs that we could not place into other groups into that one.1

3. Census matched the EINs in each group to the EINs of respondents to 

their surveys. Census then aggregated the economic data, such as value 

added, number of paid employees, and capital expenditures, for all of 

the EINs in a given group and industry. Census did the same for the 

EINs in our “unknown” group, but for that group they also provided a 

breakdown according to the type of business entity that the 

respondents reported themselves to be in the Census surveys. Census 

reviewed these results to ensure compliance with their legal 

requirement to ensure confidentiality of individual survey respondents; 

they suppressed the data in any entity-industry grouping that, 

otherwise, would have disclosed confidential information. In some 

cases we combined two of our original groups to avoid having data 

suppressed.

4. Where possible, we added the data from 1 of our 10 entity groups to the 

data from one or more of the entity categories that Census identified in 

our unknown group. For example, we added data for partnerships that 

Census identified to the data for our pass-through entity group.

1

We followed a similar procedure for an additional set of 84 EINs that were not in Census’s 

original EINs, but that we identified in IRS data as businesses with income earned in Puerto 

Rico.
Appendix III

Methodology for Analyses of Business 

Activities

Page 144 GAO-06-541 Puerto Rican Fiscal and Economic Trends

The entity groupings that we report in our figures and tables are defined as 

follows:

Possessions corporations. All EINs associated with corporations that IRS 

identified as being a possessions corporation in 2002 and which were 

identified as operating in Puerto Rico.

U.S. CFCs.

2

 This category contains all EINs belonging to corporations that 

(1) were reported on a form 5471 in 2001 or 2002; (2) were identified for us 

as U.S. CFCs by the Puerto Rico Industrial Development Company 

(PRIDCO), which gathered information from the Office of Industrial Tax; or 

(3) were incorporated outside of the United States, had no record of a filing 

a standard form 1120 (corporate tax return) or 1065 (partnership tax 

return) with IRS, and had names indicating they were members of one of 

the 77 large U.S. corporate groups operating in Puerto Rico. We divided this 

category into two groups, depending on whether a form 5471 or a Puerto 

Rican tax return identified the corporation as being incorporated in Puerto 

Rico or elsewhere.

Other U.S. Corporations. This category contains EINs of corporations that 

were incorporated in the United States, but were not possessions or passthrough (partnership) corporations.

Other corporations incorporated in Puerto Rico. These were corporations 

for which we found Puerto Rican tax returns that identified the place of 

incorporation as Puerto Rico, but which did not meet the criteria we used 

to identify CFCs.

Corporations of type unknown. The overwhelming majority of the EINs 

that we sent to Census in this group were for employers that we 

determined to be corporations (because their name did not suggest they 

were a partnership or LLC, they filed a form 1120-F [tax return of a foreign 

corporation], or their name indicated that they were corporations) and for 

which we had no indicator of a place of incorporation. We also included 

small numbers of three other types of corporations in this category because 

disclosure constraints prevented us from reporting on them separately. 

They are (1) CFCs for which we could not determine a place of 

incorporation, (2) corporations that were incorporated outside of the 

2

For the Census groupings we did not need to establish a connection to Puerto Rico with our 

tax data because Census established those connections through their surveys.
Appendix III

Methodology for Analyses of Business 

Activities

Page 145 GAO-06-541 Puerto Rican Fiscal and Economic Trends

United States or Puerto Rico but which were not CFCs, and (3) nonprofit 

corporations that Census identified from our unknown group but whose 

data they suppressed.3

Sole proprietors. This category contains EINs that were associated with 

sole proprietors in IRS’s records or in Census’s surveys. 

Pass-through entities. This category contains EINs for employers that IRS 

reported to have filing requirements as partnerships or subchapter S 

corporations, or that had names on Puerto Rican tax returns indicating that 

they were partnerships or LLCs.

Other entities. The IRS codes that we used to identify EINs that we put in 

this category covered government agencies, churches, nonprofits, estates 

and trusts, political organizations, homeowners organizations, and 

settlement funds. This does not imply that the Census population of 

employers included all these type of entities. We also included in this 

category the data that Census provided to us relating to nonprofit 

corporations. 

3

Census includes these nonprofits in their “corporations” category. For industries where 

Census suppressed separate figures for these nonprofits, we could not move them from the 

corporations category to the “other entities” category.
Page 146 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates ApendxiIV

Table 14: Selected Data for the Full Population of Possessions Corporations Operating in Puerto Rico, 1993–2003

Source: GAO analysis of IRS data.

Dollars in billions (constant 2005)

1993 1995 1997 1999 2001 2003

Number of corporations claiming tax 

credit 378 332 291 204 158 124

 Amount of tax credit $5.8 $3.7 $3.2 $1.8 $1.4 $1.1

 Total income 28.8 28.6 32.3 27.0 20.5 13.3

 Gross profits 24.8 26.1 30.1 24.8 18.8 12.1

 Net income 16.7 15.9 17.3 13.3 9.5 7.3

 Total assets 59.5 59.6 58.7 54.9 45.3 41.1
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 147 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 15: Selected Data for Large Corporate Groups Operating in Puerto Rico, by Type of Entity, 1993–2003

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Dollars in billions (constant 2005)

1993 1995 1997 1999 2001 2003

 Number of corporations 

 Possessions corporations 136 146 127 105 79 58

 CFCs 34 43 49

 Other 25 28

Possessions tax credit

 Possessions corporations $5.5 $3.5 $3.0 $1.7 $1.3 $1.1

Total income

 Possessions corporations 26.7 26.8 30.7 25.9 19.8 12.5

 Lower bound for CFCs 2.4 5.2 7.4

 CFC total if allocated by tax ratio 3.0 7.2 11.5

 Other affiliates 3.3 7.5

Gross profit

 Possessions corporations 22.9 24.4 28.8 23.9 18.1 11.4

 Lower bound for CFCs 2.4 5.3 7.1

 CFC total if allocated by tax ratio 3.0 7.5 11.5

 Other affiliates 3.0 7.0

Net income

 Possessions corporations 15.9 15.1 16.6 12.8 9.3 7.1

 Lower bound for CFCs 1.6 2.4 3.9

 CFC total if allocated by tax ratio 1.9 3.4 6.0

 Other affiliates 2.1 5.8

Total assets

 Possessions corporations 54.3 54.4 54.4 50.8 42.3 38.2

 Lower bound for CFCs 7.8 14.5 16.7

 Other affiliates 6.7 7.2
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 148 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 16: Selected Data for Large Corporate Groups Operating in the Chemical and Medical Equipment Industries in Puerto 

Rico, by Type of Entity, 1993–2003

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Dollars in billions (constant 2005)

 1993 1995 1997 1999 2001 2003

Number of corporations 

 Possessions corporations 74 74 60 52 38 27 

 CFCs 15 21 26 

 Other 17 18

 Possessions tax credit

 Possessions corporations $3.1 $2.3 $2.2 $1.2 $0.9 $0.8

 Total income

 Possessions corporations 15.9 18.2 22.0 19.4 13.0 9.3

 Lower bound for CFCs 1.8 3.7 4.7

 CFC total if allocated by tax ratio 1.8 5.7 8.8

 Other affiliates 2.8 7.3

 Gross profit

 Possessions corporations 15.4 17.0 21.0 18.3 12.0 8.6

 Lower bound for CFCs 1.8 4.0 4.8

 CFC total if allocated by tax ratio 1.8 6.1 9.1

 Other affiliates 2.7 6.9

 Net Income

 Possessions corporations 8.9 10.7 12.4 10.2 6.8 5.5

 Lower bound for CFCs 1.2 2.3 2.8

 CFC total if allocated by tax ratio 1.2 3.4 4.8

 Other affiliates 2.0 5.8

 Total assets

 Possessions corporations 29.7 32.7 30.1 33.1 25.2 23.3

 Lower bound for CFCs 2.3 4.9 7.7

 Other affiliates 5.5 6.0
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 149 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 17: Selected Data for Large Corporate Groups Operating in the Computer, Electronics, and Electrical Equipment Industries

in Puerto Rico, by Type of Entity, 1993–2003

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Dollars in billions (constant 2005)

 Large computer/electronics/electrical equipment groups

 1993 1995 1997 1999 2001 2003

 Number of corporations 

 Possessions corporations 15 29 25 16 13 11 

 CFCs 10 10 12 

 Other 6 4 

 Possessions tax credit

 Possessions corporations $1.2 $0.3 $0.2 $0.1 $0.1 $0.1

 Total income

 Possessions corporations 3.9 1.9 2.1 0.8 1.8 0.6

 CFCs 0.2 0.2 0.3

 Other affiliates 0.5 0.1 

 Gross profit

 Possessions corporations 1.6 1.8 2.0 0.7 1.7 0.4

 CFCs 0.2 0.2 0.2

 Other affiliates 0.4 0.0

 Net income

 Possessions corporations 3.3 1.1 1.0 0.5 0.5 0.5

 CFCs 0.1 0.2 0.2

 Other affiliates 0.1 0.0 

 Total assets

 Possessions corporations 3.3 5.0 5.2 2.8 2.1 1.7

 CFCs 0.5 0.7 2.3

 Other affiliates 1.2 0.8
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 150 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 18: Selected Data for Large Corporate Groups Operating in the Food and Kindred Products Industries in Puerto Rico, by 

Type of Entity, 1993–2003

Source: GAO analysis of data from IRS and the Puerto Rican Department of Treasury.

Note: Other affiliates of possessions corporations had less than $0.1 billion of all of these measures.

Dollars in billions (constant 2005)

 Possessions corporations in the large food and kindred products groups

 1993 1995 1997 1999 2001 2003

Number of corporations 14 17 17 15 11 6 

Possessions tax credit 0.7 0.4 0.2 0.2 0.2 0.1

Total income 3.1 3.0 2.3 4.0 3.9 1.6

Gross profit 2.9 2.3 1.8 3.2 3.4 1.6

Net income 2.1 1.8 1.5 1.6 1.5 0.9

Total assets 5.4 6.4 9.2 10.6 11.3 9.8
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 151 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 19: Distribution of Tax Credits, Income, and Assets of Possessions Corporations Operating in Puerto Rico, by Industry, 

1993–2003

Percent

 1993 1995 1997 1999 2001 2003

 Possessions tax credit

 Apparel 1.2 1.9 2.4 6.1 5.7 0.8

 Beverages and tobacco 12.8 10.8 6.6 9.3 12.7 10.8

 Computers, electronics, and electrical equipment 21.5 9.4 8.2 8.5 9.7 13.8

 Medical equipment 8.6 10.1 11.3 9.8 11.6 7.8

 Nonmanufacturing 3.7 4.8 4.9 2.4 2.7 10.6

 Other manufacturing 5.7 7.4 6.0 6.4 6.7 5.8

 Pharmaceuticals 46.5 55.7 60.5 57.6 50.9 50.4

 Total income

 Apparel 0.8 1.1 1.0 1.4 1.7 1.1

 Beverages and tobacco 10.9 10.4 6.9 14.6 19.2 12.5

 Computers, electronics, and electrical equipment 14.7 7.3 7.0 3.1 9.0 5.4

 Medical equipment 7.9 7.7 9.3 6.3 7.6 7.8

 Nonmanufacturing 10.0 9.1 8.9 5.4 4.6 6.1

 Other manufacturing 5.8 6.0 4.2 2.8 3.4 3.7

 Pharmaceuticals 49.9 58.4 62.7 66.4 54.4 63.5

 Gross profits

 Apparel 0.9 1.2 1.0 1.5 1.8 1.2

 Beverages and tobacco 12.1 8.7 5.8 12.9 18.2 13.5

 Computers, electronics, and electrical equipment 7.2 7.5 7.0 3.2 9.8 3.6

 Medical equipment 8.7 7.9 9.3 6.3 7.8 6.9

 Nonmanufacturing 7.9 9.0 8.7 4.3 2.9 4.8

 Other manufacturing 6.5 5.8 4.2 2.7 3.8 4.0

 Pharmaceuticals 56.6 60.0 64.0 69.1 55.8 66.0

 Net income

 Apparel 1.2 1.8 1.6 2.5 3.0 1.5

 Beverages and tobacco 13.0 11.7 8.5 12.1 16.0 11.6

 Computers, electronics, and electrical equipment 21.3 7.7 6.0 3.8 5.9 7.1

 Medical equipment 8.8 9.3 10.9 6.2 8.4 8.9

 Nonmanufacturing 3.9 3.4 2.8 1.6 1.6 0.8

 Other manufacturing 5.7 6.6 4.5 2.0 1.5 2.1

 Pharmaceuticals 46.2 59.6 65.7 71.8 63.6 67.9
Appendix IV

Additional Data on Possessions Corporations 

and Their Affiliates

Page 152 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Source: GAO analysis of data from IRS.

 Total assets

 Apparel 0.5 0.5 0.5 0.8 2.5 3.0

 Beverages and tobacco 9.5 11.1 16.0 19.4 25.2 25.4

 Computers, electronics, and electrical equipment 6.3 8.9 7.9 5.6 4.9 4.4

 Medical equipment 10.8 12.9 10.7 5.1 5.4 6.4

 Nonmanufacturing 21.1 10.2 12.9 11.7 10.9 11.6

 Other manufacturing 9.0 8.1 7.0 5.9 5.5 3.4

 Pharmaceuticals 42.8 48.3 45.1 51.5 45.6 45.7

(Continued From Previous Page)

Percent

 1993 1995 1997 1999 2001 2003
Page 153 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity ApendxiV

(Page is left blank intentionally.)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 154 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 20: Employment in Puerto Rican Manufacturing by Industry and Business Entity Type, 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for entities in the “all other employers” group in 

manufacturing. However, we were able to impute employment figures for this group by calculating the 

residual of employees not included in any other group.

b

The data in this line do not include those for five partnerships that we were able to identify, but which 

we could not add into this line (see app. III for explanation). Data for those five partnerships, which 

together had between 100 and 249 employees, are included in the “all other employers” line.

c

The data for sole proprietors are from the published version of the 2002 Economic Census of Island 

Areas (see app. III for explanation). 

Type of business entity All manufacturing Food Beverages Apparel

All employersa 126,707 14,509 3,859 9,731

Possessions corporations 40,313 3,218 1,991 5,735

Other U.S. corporations 11,006 1,238 250–499 436

CFCs incorporated in Puerto Rico 8,973 20–99 0 100–249

CFCs incorporated outside of Puerto Rico 8,657 0 0 0

Other corporations incorporated in Puerto 

Rico 28,630 6,155 509 2,751

Corporations of type unknown 14,642 (D) (D) (D)

Pass-through entitiesb 3,949 0–19 250–499 20–99

Sole proprietorsc 2,933 (D) (D) (D)

All other employers 7,604 898–996 0–452 0–114
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 155 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Pharmaceuticals Machinery

Computers and

electronics Medical equipment All other manufacturing

25,036 1,697 17,989 16,241 37,645

7,772 500–999 6,017 7,246 7,335–7,834

1,744 100-249 1,111 1,191 4,538–4,936

4,443 0 1,000–2,499 540 1,143–2,870

2,961 0 2,500–4,999 2,078 0–1,118

2,712 474 1,752 491 13,786

(D) (D) (D) (D) (D)

1,000–2,499 0 100–249 1,000–2,499 0–1,579

(D) (D) (D) (D) (D)

2,517–4,016 0–546 1,164–5,469 0–2,685
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 156 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 21: Value Added in Puerto Rican Manufacturing by Industry and Business Entity Type, 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for entities in the “all other employers” group in 

manufacturing. However, we were able to impute payroll figures for this group by calculating the 

residual of value added that was not included in any other group.

b

The data in this line do not include those for five partnerships that we were able to identify, but which 

we could not add into this line. Data for those five partnerships, which together had between 100 and 

249 employees, are included in the “all other employers” line.

c

The data for sole proprietors are from the published version of the 2002 Economic Census of Island 

Areas (see app. III for explanation). 

Dollars in thousands

Type of Business Entity All Manufacturing Food Beverage Apparel

All employersa 45,614,305 3,596,987 783,483 505,836

Possessions corporations 12,183,980 2,997,247 584,187 434,762

Other U.S. corporations 1,016,055 52,471 (D) 14,976

CFCs incorporated in Puerto Rico 7,057,958 (D) 0 (D)

CFCs incorporated outside of 

Puerto Rico 12,254,469 0 00

Other corporations incorporated in 

Puerto Rico 3,578,053 395,597 59,529 39,358

Corporations of type unknown 3,124,760 (D) (D) (D)

Pass-through entitiesb 3,891,900 (D) (D) (D)

Sole proprietorsc 121,954 (D) (D) (D)

All other employers 2,385,176 (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 157 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Pharmaceuticals Machinery Computers and electronics Medical equipment All other manufacturing

 33,159,557 171,969 1,878,700 1,998,440 3,519,333

6,222,318 (D) 338,847 512,883 (D)

323,294 (D) 98,679 122,964 (D)

6,511,093 0 (D) 117,270 (D)

11,118,836 0 (D) 509,005 (D)

2,236,129 17,169 148,413 15,705 666,153

(D) (D) (D) (D) (D)

 (D) 0 (D) (D) (D)

(D) (D) (D) (D) (D)

 (D) (D) (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 158 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 22: Annual Payroll in Puerto Rican Manufacturing by Industry and Business Entity Type, 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for entities in the “all other employers” group in 

manufacturing. However, we were able to impute payroll figures for this group by calculating the 

residual of payroll that was not included in any other group.

b

The data in this line do not include those for five partnerships that we were able to identify, but which 

we could not add into this line. Data for those five partnerships, which together had between 100 and 

249 employees, are included in the “all other employers” line.

c

The data for sole proprietors are from the published version of the 2002 Economic Census of Island 

Areas (see app. III for explanation). 

Dollars in thousands

Type of business entity All manufacturing Food Beverage Apparel

All employersa

C “O ”

3,130,631 230,955 102,833 161,743

Possessions corporations 1,074,215 80,356 62,082 83,816

Other U.S. corporations 217,620 12,847 (D) 4,897

CFCs incorporated in Puerto Rico 272,198 (D) 0 (D)

CFCs incorporated outside of Puerto Rico 342,960 0 0 0

Other corporations incorporated in Puerto Rico 519,675 97,606 13,329 27,007

Corporations of type unknown 299,001 (D) (D) (D)

Pass-through entitiesb 155,755 (D) (D) (D)

Sole proprietorsc 21,910 (D) (D) (D)

All other employers 227,297 (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 159 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Pharmaceuticals Machinery Computers and electronics

Medical

equipment All other manufacturing

 1,109,166 30,918 437,092 343,164 714,760

347,821 (D) 127,202 162,712 (D)

50,689 (D) 28,697 26,029 (D)

185,991 0 (D) 6,677 (D)

159,087 0 (D) 45,162 (D)

117,845 6,297 27,873 3,888 225,830

(D) (D) (D) (D) (D)

 (D) 0 (D) (D) (D)

(D) (D) (D) (D) (D)

 (D) (D) (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 160 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 23: Capital Expenditures in Puerto Rican Manufacturing by Industry and Business Entity Type, 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for entities in the “all other employers” group in 

manufacturing. However, we were able to impute figures for this group by calculating the residual of 

capital expenditures that were not included in any other group.

b

The data in this line do not include those for five partnerships that we were able to identify, but which 

we could not add into this line. Data for those five partnerships, which together had between 100 and 

249 employees, are included in the “all other employers” line.

c

The data for sole proprietors are from the published version of the 2002 Economic Census of Island 

Areas (see app. III for explanation). 

Dollars in thousands

Type of business entity All manufacturing Food Beverage Apparel

All employersa 3,673,690 84,912 57,403 6,249

Possessions corporations 904,214 47,386 12,577 1,280

Other U.S. corporations 246,259 2,127 (D) 182

CFCs incorporated in Puerto Rico 590,686 (D) 0 (D)

CFCs incorporated outside of Puerto Rico 409,731 0 0 0

Other corporations incorporated in Puerto 

Rico 674,034 24,969 34,322 4,662

Corporations of type unknown 125,890 (D) (D) (D)

Pass-through entitiesb 443,727 (D) (D) (D)

Sole proprietorsc (D) (D) (D) (D)

All other employers (D) (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 161 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Pharmaceuticals Machinery Computers and electronics Medical equipment All other manufacturing

 2,614,797 9,355 81,453 184,344 635,177

716,751 (D) 14,469 41,390 (D)

172,013 (D) 5,350 9,143 (D)

565,582 0 (D) 6,187 (D)

386,979 0 (D) 17,228 (D)

231,607 4,243 3,094 2,392 368,745

(D) (D) (D) (D) (D)

 (D) 0 (D) (D) (D)

(D) (D) (D) 0 (D)

 (D) (D) (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 162 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 24: Value of Shipments in Puerto Rican Manufacturing by Industry and Business Entity Type, 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for entities in the “all other employers” group in 

manufacturing. However, we were able to impute figures for this group by calculating the residual of 

value of shipments that were not included in any other group.

b

The data in this line do not include those for five partnerships that we were able to identify, but which 

we could not add into this line. Data for those five partnerships, which together had between 100 and 

249 employees, are included in the “all other employers” line.

c

The data for sole proprietors are from the published version of the 2002 Economic Census of Island 

Areas (see app. III for explanation). 

Dollars in thousands

Type of business entity All manufacturing Food Beverage Apparel

All employersa 58,580,060 4,883,924 1,547,995 725,181

Possessions corporations 16,010,390 3,504,753 923,020 559,109

Other U.S. corporations 2,097,568 103,317 (D) 22,800

CFCs incorporated in Puerto Rico 7,675,116 (D) 0 (D)

CFCs incorporated outside of Puerto Rico 13,912,333 0 0 0

Other corporations incorporated in Puerto Rico 5,583,289 911,875 106,780 111,327

Corporations of type unknown 4,718,126 (D) (D) (D)

Pass-through entitiesb 5,450,104 (D) (D) (D)

Sole proprietorsc 194,760 (D) (D) (D)

All other employers 2,938,374 (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 163 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Pharmaceuticals Machinery Computers and electronics Medical equipment All other manufacturing

 38,446,602 284,538 3,388,664 2,982,585 6,320,571

7,623,306 (D) 742,735 728,864 (D)

586,596 (D) 178,841 238,777 (D)

6,881,368 0 (D) 151,256 (D)

11,885,537 0 (D) 681,684 (D)

2,942,219 28,716 205,789 22,734 1,253,849

 (D) (D) (D) (D) (D)

 (D) 0 (D) (D) (D)

 (D) (D) (D) (D) (D)

 (D) (D) (D) (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 164 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 25: Share of Employment for Puerto Rico’s Manufacturing, Wholesale Trade, Retail Trade, and Services Sectors in 2002 

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

We included nonprofits in the group labeled “other employers.” However, Census included these 

employers in the group labeled “corporations of type unknown.” In order to be consistent with the 

groups that we created for the manufacturing sector, we removed nonprofits from Census’s 

“corporations of type unknown” and combined them with our “other employers” group, whenever 

possible. 

b

Census did not disclose specific employment figures for entities in the “other employers” group. 

However, we were able to impute employment figures for this group by calculating the residual of 

employees not included in any other group.

Sector or service industry

Employment

value

Possessions

(percent)

CFCs

(percent)

Other U.S.

corporations

(percent)

Manufacturing 126,707 31.8 13.9 8.7

Wholesale trade 39,316 4.9 6.6 11.6

Retail trade 122,435 2.0–4.0 9.5 12.1

Mining 949 0.0 2.1–10.4 2.1–10.4

Utilities 503 0.0 4.0–19.7 4.0–19.7

Transportation and warehousing 13,137 0.2–0.8 0.8 9.8

Information 16,696 2.4 32.7 11.0

Finance and insurance 36,059 0.1–0.3 5.1 10.9

Real estate and rental and leasing 13,086 0.2–0.8 1.5 14.8

Professional, scientific, and technical 

services 26,197 2.1 3.4 20.2

Management of companies and 

enterprises 2,237 0.0 4.5–11.1 3.9

Administrative support and waste 

management 61,703 0.2–0.4 5.1 15.4

Educational services 4,647 0.0 0.4–2.1 8.7

Health care and social assistance 68,338 0.4–0.8 3.3 11.3

Arts, entertainment, and recreation 3,115 0.0 0.0 15.3

Accommodation and food services 63,810 10.0 0.4–0.8 17.4

Other services (except public 

administration) 18,417 0.1–0.5 0.1–0.5 9.0
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 165 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Types of business entities 

Corporations of type

unknowna

 (percent)

Sole proprietors

(percent)

Partnerships

(percent)

Other corporations

incorporated in Puerto

Rico (percent)

Other employers

(percent)

11.6 2.3 3.1 22.6 6.0b

63.9 2.8–4.1 1.6 7.7 0.9–2.2

60.4 10.6 0.3 2.0–4.1 1.3

 (D) (D) 0.0 43.9 0.0

 (D) (D) 4.0–19.7 0.0 0.0

 (D) (D) 1.2–2.3 13.0 1.5–3.2

 (D) (D) 1.6–1.7 10.9 0.6

36.5 1.4 0.3–1.0 35.2 10.6–11.5

(D) (D) 11.3 1.2 2.3–4.1

(D) (D) 11.2 3.4 4.3–5.6

(D) (D) 0–0.8 22.4–44.7 0–2.5

(D) (D) 1.5–2.4 1.0 1.0–1.7

(D) (D) 0–0.4 0–0.4 29.4–35.2

 (D) (D) 1.4–1.8 0.1 33.9–38

 (D) (D) 3.9–11.2 0–0.6 19.9–43.9

 (D) (D) 6.8 2.9 0.2–0.3

 (D) (D) 3.5 0.6 16.4
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 166 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 26: Share of Sales and Value of Shipments for Puerto Rico’s Manufacturing, Wholesale Trade, Retail Trade, and Services

Sectors in 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

We generally included nonprofits in the group labeled “other employers,” however, for wholesale trade 

some nonprofits are included in the group labeled “corporations of type unknown,” as a result of the 

disclosure constraints under which we worked (see app. III for details).

b

Census did not disclose specific figures for employers in the “other employers” group in 

manufacturing. However, we were able to impute sales figures for this group by calculating the residual 

of sales not included in any other group.

Sales/value of shipments

Sector or service industry

Sales

value

Possessions

(percent)

CFCs

(percent)

Manufacturing 58,580,060 27.3 36.9

Wholesale trade 16,172,710 2.6 15.3

Retail trade 20,422,975 (D) 10.6

Mining 107,000 (D) (D)

Utilities 369,932 (D) (D)

Transportation and warehousing 2,076,573 (D) 0.8

Information 3,686,792 3.7 41.6

Finance and insurance 10,233,015 (D) 8.4

Real estate and rental and leasing 1,698,631 (D) 3.0

Professional, scientific, and technical services 2,836,774 2.5 4.6

Management of companies and enterprises 511,676 (D) (D)

Administrative support and waste management 2,336,978 (D) 7.0

Educational services 242,810 (D) (D)

Health care and social assistance 4,967,317 (D) 3.0

Arts, entertainment, and recreation 278,975 0.0 0.0

Accommodation and food services 3,360,226 10.1 (D)

Other services (except public administration) 1,470,563 (D) (D)
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 167 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Types of business entities 

Other U.S.

corporations

(percent)

Corporations of type

unknowna

(percent)

Sole proprietors

(percent)

Partnerships

(percent)

Other corporations

incorporated in

Puerto Rico

(percent)

Other

employers

(percent)

3.6 8.1 0.3 9.3 9.5 5.0b

10.3 60.0 (D) (D) 8.0 (D)

12.4 61.2 5.1 0.2 (D) 1.1

(D) (D) (D) (D) 50.5 (D)

(D) (D) (D) (D) (D) (D)

9.3 (D) (D) (D) 3.9 0.4

13.0 (D) (D) 1.5 9.2 0.2

10.7 (D) (D) (D) 22.6

14.9 (D) (D) 12.0 1.6 (D)

21.7 (D) (D) 12.7 2.8 (D)

1.9 (D) (D) (D) (D) (D)

20.3 (D) (D) (D) 2.1 (D)

14.1 (D) (D) (D) (D) (D)

14.8 (D) (D) (D) 0.1 (D)

(D) (D) (D) (D) (D) (D)

(D) (D) (D) 7.4 3.3 (D)

8.7 (D) (D) 7.1 1.1 16.5
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 168 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 27: Share of Payroll for Puerto Rico’s Manufacturing, Wholesale Trade, Retail Trade, and Services Sectors in 2002

Source: GAO analysis of IRS data and custom tabulations from the 2002 Economic Census of Island Areas provided by the U.S. Census 

Bureau.

Notes: We use the symbol (D) in this table to represent data that Census withheld to avoid disclosing 

information for individual companies.

a

Census did not disclose specific figures for employers in the “other employers” group in 

manufacturing. However, we were able to impute payroll figures for this group by calculating the 

residual of employees not included in any other group.

Payroll

Sector or service industry

Payroll

value

Possessions

(percent)

CFCs

(percent)

Other U.S.

corporations

(percent)

Manufacturing 3,130,631 34.3 19.6 7.0

Wholesale trade 1,009,360 5.5 10.4 13.3

Retail trade 1,655,584 (D) 11.2 11.8

Mining 18,834 0.0 (D) (D)

Utilities 21,040 0.0 (D) (D)

Transportation and warehousing 253,758 (D) 1.0 10.2

Information 633,161 2.9 35.0 9.9

Finance and insurance 1,152,628 (D) 6.5 10.0

Real estate and rental and leasing 231,189 (D) 2.5 16.3

Professional, scientific, and technical 

services 701,485 2.3 4.1 23.5

Management of companies and 

enterprises 79,091 0.0 (D) 2.5

Administrative support and waste 

management 888,063 (D) 7.0 0.0

Educational services 74,829 (D) (D) 9.8

Health care and social assistance 1,224,260 (D) 3.9 13.1

Arts, entertainment, and recreation 45,393 0.0 0.0 14.9

Accommodation and food services 732,147 10.3 (D) 22.6

Other services (except public 

administration) 281,805 (D) (D) 8.9
Appendix V

Additional Data on the Distribution of 

Business Activity by Type of Business Entity

Page 169 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Types of business entities 

Corporations of type

unknown

(percent)

Sole proprietors

(percent)

Partnerships

(percent)

Other corporations

incorporated in

Puerto Rico

(percent)

Other

employers

9.6 0.7 5.0 16.6 7.3a

59.5 (D) (D) 7.5 (D)

61.6 7.6 0.3 (D) 1.0

 (D) (D) 0.0 57.3 0.0

 (D) (D) (D) (D) 0.0

 (D) (D) (D) 8.1 (D)

 (D) (D) (D) 13.7 0.4

 (D) (D) (D) 34.1 (D)

 (D) (D) 11.8 1.4 (D)

 (D) (D) 14.0 3.0 (D)

 (D) (D) (D) (D) (D)

 (D) (D) (D) 1.6 (D)

 (D) (D) (D) (D) (D)

 (D) (D) (D) 0.2 (D)

 (D) (D) (D) (D) (D)

 (D) (D) 9.8 3.7 (D)

 (D) (D) 6.0 1.0 17.2
Page 170 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix VI

Additional Comparative Fiscal Data ApendxiVI

This appendix provides more detail on how Puerto Rico’s fiscal situation 

compares to the states and the other insular areas.

Table 28: Federal, State, Commonwealth, and Insular Area Revenues Collected in Fiscal Year 2002a

Source: GAO analysis of IRS, Customs, and Insular Area Treasury Department data.

a

Data reflect fiscal year of the jurisdiction. The federal government’s fiscal year and those of the other 

insular areas end September 30, 2002. Puerto Rico’s and most states’ fiscal years end June 30, 2002.

b

Excludes states with zero values.

c

All federal tax figures represent net tax collections. 

d

Does not include the federal corporate income tax.

e

Not available, IRS does not report data separately for insular areas, other than Puerto Rico.

Fiscal activity

Puerto Rico

Revenues

(in thousands) Per capita

Percent of

commonwealth

personal income

Nationwide

per capita

Total revenue $11,847,725 $3,070.6 28.2 $9,425.1

 Federal taxc

 Totald 2,933,360 760.1 7.0 5,618.8

 Individual and 

 employment tax 2,929,247 759.1 7.0 5,346.1

 Estate and gift tax 4,730 1.2 0.0 91.5

 Excise tax -617 -0.2 0.0 181.2

 State and entity 

 revenues

 Total 8,914,365 2,310.0 21.2 3,806.2

 Corporate 

 income tax 1,768,322g 458.2 4.2 111.6

 Individual 

 income taxh 2,526,840 654.8 6.0 863.8

 Nonresident 

 withholding 583,256 151.1 1.4

 Property tax 768,065 199.0 1.8 992.1

 Sales and excise 

 tax 2,745,974 711.6 6.5 1,151.7

 Other taxes and 

 nontax revenues 521,908 135.2 1.2 841.7
Appendix VI

Additional Comparative Fiscal Data

Page 171 GAO-06-541 Puerto Rican Fiscal and Economic Trends

f

A more detailed breakdown is not available. 

g

Includes partnerships and tollgate taxes.

h

Census data for income tax include dividend and interest income. Puerto Rican Treasury data listed 

these items separately. For the purpose of comparison we added them together.

States Insular areas

High five

per capita

Low five

per capitab

Nationwide percent

of state personal

income

High five percent

of state personal

income

Low five percent

of state

personal income

Combined

per capita

$15,490.5 $5,712.9 29.9 41.4 23.0 $2,450.6

10,732.7 2,784.6 17.8 28.9 11.1 n.a.e

9,066.1 2,526.1 17.0 22.4 10.1

164.6 30.2 0.3 0.4 0.1

643.7 15.4 0.6 2.2 0.1

5,359.7 2,682.7 12.1 15.1 10.2 2,450.6f

278.7 39.2 0.4 0.8 0.1

1,444.3 44.9 2.7 4.0 0.3

1,589.8 394.8 3.1 4.8 1.5

1,834.2 359.4 3.7 5.9 1.2

2,183.8 517.8 2.7 7.4 1.8
Page 172 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix VII

Additional Details on the Application of 

Federal Social Programs ApendxiVI

Education Programs

Individuals with Disabilities 

Education Act Part B

The Individuals with Disabilities Education Act (IDEA) is the primary 

federal law that addresses the unique needs of children with disabilities, 

including children with specific learning disabilities, speech and language 

impairments, mental retardation, and serious emotional disturbance. The 

law mandates that a free, appropriate public education be made available 

for all eligible children with disabilities. As such, local education agencies 

are required to provide accommodations for children as needed, including 

accommodations for instruction and assessment. IDEA also requires the 

inclusion of students with disabilities in state- and districtwide assessment 

programs and the placement of students in the least restrictive 

environment, to the maximum extent appropriate. Teachers and staff work 

with parents and special education experts to create individualized 

education programs (IEP) for students with disabilities. These IEPs outline 

academic goals, appropriate accommodations, and measurable objectives. 

IDEA provides grants to states to help them implement the requirements. 

All 50 states, Puerto Rico, and all insular areas must comply with IDEA 

requirements as a condition of funding. Part B of IDEA authorizes grants 

for children age 3 to 21 with disabilities and contains provisions regarding 

the structure of special education and related services and the procedural 

safeguards that guarantee the provision of a free and appropriate public 

education to children with disabilities. Information on the special 

education students and grants provided under IDEA part B for fiscal year 

2002 is summarized in table 29. 
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Federal Social Programs

Page 173 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 29: Special Education Grant Allocation to, and Number of Students Covered 

by IDEA Part B in, the States and Puerto Rico Authorized by IDEA Part B, Fiscal Year 

2002 

Source: U.S. Department of Education.

Title I of the Elementary and 

Secondary Education Act

Title I of the Elementary and Secondary Education Act, reauthorized by the 

No Child Left Behind Act of 2001,1

 is the largest federal program supporting 

elementary and secondary education; with annual expenditures of more 

than $10.3 billion, the Act accounts for about 3 percent of total education 

expenditures nationally. Title I is an important source of funding for many 

high-poverty school districts and individual schools as funds are directed 

toward states and school districts with greater numbers and percentages of 

poor children. Title I offers grants designed to help local education 

agencies and schools improve the teaching and learning of children failing, 

or most at risk of failing, to meet state academic standards. The program 

aims to ensure that all children have a fair, equal, and significant 

opportunity to obtain a high-quality education and reach or exceed 

proficiency on state academic achievement standards and assessments. 

Program goals can be accomplished by efforts including 

1. ensuring that high-quality academic assessments, accountability 

systems, teacher preparation and training, curriculum, and 

instructional materials are aligned with challenging state academic 

standards; 

2. meeting the educational needs of low-achieving children in the nation’s 

highest-poverty schools, limited-English-proficient children, migratory 

 Total for the states, 

Puerto Rico, and the 

other insular areas Puerto Rico

 Puerto Rico 

as percent of 

total

Special education allocation $7,528,533,000 $67,879,755 0.9

Number of students 48,995,357 596,502 1.2

Number of students with 

individualized education 

programs 6,531,405 69,327 1.1

1

Pub. L. No. 107-110.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 174 GAO-06-541 Puerto Rican Fiscal and Economic Trends

children, children with disabilities, Indian children, neglected or 

delinquent children, and young children in need of reading assistance;

3. closing the achievement gap between high- and low-performing 

children; 

4. holding schools, local educational agencies, and states accountable for 

improving the academic achievement of all students and identifying 

and improving low-performing schools, while providing alternatives to 

students in such schools to enable them to receive a high-quality 

education; and

5. distributing and targeting resources sufficiently to make a difference to 

local educational agencies and schools where needs are greatest.

Title I funds are provided to the states, Puerto Rico, and the other insular 

areas, and all must comply with the same requirements of the law as a 

condition of funding. Each location has established its own specific 

performance goals and program accountability system (e.g., academic 

assessments, graduation rates, teacher qualifications), consistent with 

federal regulations. Table 30 shows Title I grant data for Puerto Rico 

relative to national data for fiscal year 2002. 

Table 30: Title I Grant Allocation and Number of Covered Students, Fiscal Year 2002

Source: U.S. Department of Education. 

Food and Nutrition 

Programs

The Child and Adult Care 

Food Program 

The Child and Adult Care Food Program (CACFP) serves nutritious meals 

and snacks to eligible children and adults who are enrolled for care at 

Total for the states, 

Puerto Rico, and the 

other insular areas Puerto Rico

Puerto Rico as

percent of total

Title I grant allocation $10.35 billion $333,295,520 3.3

Number of students 48,995,357 596,502 1.2
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 175 GAO-06-541 Puerto Rican Fiscal and Economic Trends

participating child-care centers, day-care homes, and adult day-care 

centers. CACFP also provides meals to children residing in homeless 

shelters and snacks to youths participating in after-school care programs. 

Meal providers in licensed care facilities or institutions receive 

reimbursement per meals served; meals must meet nutrition guidelines. 

Reimbursement rates are adjusted for changes in the consumer price index 

(CPI)2

 for food-away-from-home. This program was started in 1975 as the 

Child Care Food Program. In 1989, the name of the program was changed 

to Child and Adult Care Food Program.3

CACFP operates in the same way in the states, the U.S. Virgin Islands, 

Puerto Rico, and Guam, and has the following characteristics:

• The target population includes children, chronically impaired adults, 

and adults 60 or older who eat meals in group settings, such as centers, 

homes, and shelters. Teenagers in after-school programs in low-income 

areas can also participate.

• Public or private not-for-profit and for-profit centers may participate. 

For-profit centers must have at least 25 percent low-income 

participants; there is no similar requirement for not-for-profit centers. 

• In centers, participants from households with income at or below 130 

percent of the federal poverty level (FPL) can receive free meals, and 

those with income between 130 and 185 percent can receive reducedprice meals. Low-income day-care providers or day-care homes in lowincome areas can receive reimbursement at higher rates than those for 

other homes. 

CACFP does not operate in CNMI and American Samoa; however, the 

Nutrition Assistance Program block grant can be used to provide such 

meals and snacks in American Samoa. 

Food Stamp and Nutrition 

Assistance Programs

Created in 1964, the Food Stamp Program is intended to help low-income 

individuals and families obtain a more nutritious diet by supplementing 

2

The consumer price index is a measure of the average change in prices over time in a given 

market basket of goods.

3

Pub. L. No. 101-147. 
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 176 GAO-06-541 Puerto Rican Fiscal and Economic Trends

their income with benefits to purchase food.4 The structure of the Food 

Stamp Program is the same in the states, the U.S. Virgin Islands, and Guam. 

Puerto Rico, CNMI, and American Samoa do not operate the Food Stamp 

Program; instead, they receive block grants from the federal government, 

which are referred to as Nutrition Assistance Programs, whose design and 

eligibility rules differ from those of the Food Stamp Program. Table 31 

summarizes the key features of these programs.

Table 31: Comparison of the Food Stamp and Nutrition Assistance Programs

Source: GAO analysis of U.S. Department of Agriculture (USDA) Food and Nutrition Service documents and interviews with program 

staff.

a

The thrifty food plan is a market basket of foods for a nutritious, low-cost diet for a four-person 

reference family. 

4

Pub. L. No. 88-525.

Food Stamp Program Nutrition Assistance Programs

The states, the U.S. Virgin 

Islands, Guam Puerto Rico CNMI American Samoa

Funding basis Entitlement based on number 

of participants; benefits 

adjusted annually to reflect 

changes in the thrifty food 

plan.a

Capped block 

grant adjusted to 

reflect the percent 

change in the 

indexed level of 

the thrifty food 

plan.

Capped block grant, the 

amount of which is agreed 

to annually in a 

memorandum of 

understanding.

Capped block grant 

adjusted to reflect the 

percent change in the 

indexed level of the 

thrifty food plan.

Eligibility rules Complex formula based on 

household size, income, 

assets, and other factors. 

Generally, household net 

income cannot exceed 100 

percent of the federal poverty 

level. Hawaii, Alaska, the U.S. 

Virgin Islands, and Guam 

have slightly different 

eligibility criteria. 

Formula similar to 

Food Stamp 

Program. 

Has its own rules, some of 

which differ from those in 

the Food Stamp Program, 

to stay within the capped 

block grant. 

Has its own rules, some 

of which differ from the 

Food Stamp Program, to 

stay within the capped 

block grant. Serves only 

low-income elderly, blind, 

and disabled individuals.

Average monthly benefit 

amount per person 

(fiscal year 2003)

$84 for the 50 states, $92 for 

the District of Columbia, $119 

for the U.S. Virgin Islands, 

and $186 for Guam. 

$103 $79 $103 

Administrative costs States and insular areas each 

fund about half.

Block grant and 

Puerto Rico each 

fund about half. 

Block grant funds all. Block grant funds all. 
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 177 GAO-06-541 Puerto Rican Fiscal and Economic Trends

National School Lunch 

Program

The National School Lunch Program (NSLP) was created in 1946 to provide 

nutritionally balanced, low-cost or free lunches to children in public and 

not-for-profit private schools and residential child-care institutions. The 

program was expanded in 1998 to include snacks served in after-school and 

enrichment programs.5

The NSLP operates in the same way in the states, the U.S. Virgin Islands, 

Puerto Rico, and Guam. The program provides free meals to children from 

families with incomes at or below 130 percent of the FPL.6

 Children from 

families with incomes between 130 and 185 percent of the FPL can receive 

reduced-price meals for which no more than 40 cents may be charged. 

Children from families with incomes above 185 percent of the FPL pay full 

price. Local officials who administer the program decide what fees to 

charge for full-price meals and determine participants’ eligibility. NSLP 

does not operate in CNMI or American Samoa, but funds provided under 

the Nutrition Assistance Program block grant support lunches and snacks 

for school age children in these insular areas.

NSLP is an entitlement program. School districts and independent schools 

that take part in the lunch program are reimbursed for each meal served 

and get donated commodities from the U.S. Department of Agriculture 

(USDA). In return, they must serve lunches that meet federal nutrition 

requirements and offer free or reduced-price lunches to eligible children. 

Reimbursement rates are adjusted with changes in the CPI for food-awayfrom-home.7

 The reimbursements rates for the 2003–2004 school year are 

summarized in table 32.

5

There is also a school breakfast program, which is not included in this description.

6

For 2005, the FPL in the 48 contiguous states and the District of Columbia was $19,350 for a 

family of four. 

7

The consumer price index is a measure of the average change in prices over time in a given 

market basket of goods.
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Additional Details on the Application of 

Federal Social Programs

Page 178 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 32: National School Lunch Program Reimbursement Rates, School Year 2003–2004

Source: USDA Food and Nutrition Service documents. 

Special Supplemental 

Nutrition Program for 

Women, Infants, and 

Children

The Special Supplemental Nutrition Program for Women, Infants, and 

Children (WIC) was created in 1972.8

 WIC is designed to safeguard the 

health of low-income women who are pregnant, postpartum, or 

breastfeeding; infants; and children up to age 5 who are at nutritional risk. 

Participants receive supplemental nutritious foods, nutrition education and 

counseling, and screening and referrals to other health, welfare, and social 

services. WIC is a federal grant program for which Congress authorizes a 

specific amount each year. Participants’ income must not exceed 185 

percent of the FPL. They must also meet state residency requirements and 

be determined by a health professional to be at nutritional risk. WIC 

operates the same in the states, American Samoa, Guam, Puerto Rico, and 

the Virgin Islands. There is no WIC program in CNMI. Table 33 below 

provides estimated food and nutrition program federal expenditures for the 

states, Puerto Rico, and the other U.S. insular areas for fiscal year 2003. 

Reimbursement category

48 contiguous

states Alaska Hawaii Puerto Rico Guam

The U.S. 

Virgin Islands

Free $2.19 $3.55 $2.55 $2.19 $2.21 $2.36

Reduced 1.79 3.15 2.15 1.79 1.81 1.96

Full 0.21 0.34 0.24 0.21 0.23 0.29

8

Pub. L. No. 92-433.
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Additional Details on the Application of 

Federal Social Programs

Page 179 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 33: Estimated Food and Nutrition Program Federal Expenditures for the States, Puerto Rico, and the Other U.S. Insular 

Areas, Fiscal Year 2003

Source: GAO analysis of USDA Food and Nutrition Service documents and interviews with program staff. 

Note: n.a. = Estimates not available.

Health Care Financing 

and Grants Programs

Medicare Created in 1965 as Title XVIII of the Social Security Act, Medicare provides 

health insurance coverage for the elderly and disabled, as well as for 

individuals with end-stage renal disease. The Medicare program covers 

beneficiaries in the states and American Samoa, CNMI, Guam, Puerto Rico, 

and the U.S. Virgin Islands. In fiscal year 2003, over 41 million beneficiaries 

had Medicare coverage, including nearly 600,000 in the U.S. insular areas, 

and Medicare spending represented the largest single source of federal 

health care spending nationwide. 

Medicare includes separate components, or “parts,” that cover different 

types of services. Individuals eligible for Medicare automatically receive 

Hospital Insurance, known as Part A, which helps pay for inpatient hospital 

care, skilled nursing facility services following a hospital stay, certain home 

health services, and hospice care. U.S. residents aged 65 or over are 

automatically entitled to Medicare Part A if they or their spouses are

Program 50 States

The District 

of Columbia Puerto Rico

The U.S. 

Virgin 

Islands Guam CNMI

American 

Samoa

Food Stamp 

Program/Nutrition 

Assistance Program $21.3 billion $90.1 million $1.4 billion $18.5 million $53.4 million $7.1 million $5.6 million

National School Lunch 

Program 7.0 billion 16.5 million 123 million 4.6 million 3.8 million 5.0 million 11.2 million

WIC 4.1 billion 11.0 million 169 million 5.3 million 5.3 million n.a. 5.9 million

Child and Adult Care 

Food Program 1.9 billion 3.1 million 20.0 million 597,000 54,000 n.a. n.a.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 180 GAO-06-541 Puerto Rican Fiscal and Economic Trends

eligible for Social Security payments.9 Medicare-eligible individuals may 

elect to purchase Part B Supplemental Medical Insurance, which helps pay 

for certain physician, outpatient hospital care, laboratory, and other 

services. Part C encompasses private health plans that provide Medicare 

covered benefits to enrollees. Part D is the outpatient prescription drug 

benefit that was authorized in 2003 and was implemented in January 2006. 

In fiscal year 2003, federal Medicare expenditures totaled over $274 billion. 

In that year, total Medicare enrollment in Puerto Rico was over 574,000 and 

total expenditures were nearly $1.6 billion. 

Table 34: Estimated Medicare Enrollment and Expenditures as of July 2003, Fiscal 

Year 2003

Source: GAO analysis of data from the Centers for Medicare and Medicaid Services (CMS).

a

Enrollment includes individuals enrolled in Part A or Parts A and B of the program.

b

Expenditures include benefit payments and exclude program administration.

Medicare beneficiaries in Puerto Rico and the other insular areas have been 

treated the same as those in the states in terms of eligibility and entitlement 

to benefits; however, certain structural differences, such as the methods 

used to calculate Medicare payments to hospitals, exist. For example, 

Medicare reimburses hospitals in Puerto Rico under a prospective payment 

system (PPS) distinct from the PPS used for hospitals in the states.10 Each 

9

Social Security benefits are paid to workers who meet requirements for age and for the 

time they have worked in “covered employment,” that is, jobs through which they have paid 

Social Security taxes. Typically, workers must contribute for a total of 40 quarters (or 10 

years in total) to qualify, though the requirements are different if they become disabled or 

die. Benefits are also paid to qualified spouses and certain divorced spouses of workers who 

have met the covered employment requirement or who are disabled. Social Security covers 

about 96 percent of all U.S. workers; the vast majority of the rest are state, local, and federal 

government employees. 

Total for the 

states, Puerto 

Rico, and the 

other insular 

areas Puerto Rico 

Puerto Rico as

percent of total

Enrollmenta 40.2 million 575,000 1.4

Federal expendituresb $274.3 billion $1.6 billion 0.6

10Puerto Rico is the only insular area for which hospitals are paid using a PPS. The other 

insular area hospitals are paid based on their costs. 
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Federal Social Programs

Page 181 GAO-06-541 Puerto Rican Fiscal and Economic Trends

of Puerto Rico’s PPS rates is a “blended rate,” comprising 75 percent of the 

national rate used for hospitals in the states and 25 percent of a local rate, 

which is lower than the national rate. The rates are further adjusted for 

each hospital using cost factors. These adjustments account for the lower 

costs of providing hospital services in Puerto Rico compared to the states 

and for differing costs among hospitals across Puerto Rico. 

The Medicare Part D prescription drug program marks the first time that 

Medicare beneficiaries in the insular areas are treated differently with 

regard to available benefits. In 2004 and 2005, Medicare beneficiaries in the 

states who enrolled paid a fee to receive a discount drug card, with an 

expected discount of 10 to 15 percent on covered drugs, and certain lowincome beneficiaries who participated were entitled to assistance to 

subsidize drug costs, in an amount generally $600 per year. In contrast, 

beneficiaries in Puerto Rico and the other insular areas did not receive 

these direct benefits. Instead, each insular area was given a lump sum, 

which most, including Puerto Rico, used to subsidize Medicaid prescription 

drug coverage to certain low-income Medicare beneficiaries. The 

permanent Part D program, which went into effect in January of 2006, 

allows for similar coverage to most beneficiaries in the insular areas and 

states. However, as in the interim program, certain low-income 

beneficiaries in the insular areas will not directly receive funds to subsidize 

their prescription drug expenses. Instead, the insular areas’ governments 

will receive a lump-sum payment and administer benefits to certain lowincome beneficiaries based on a locally developed plan. 

Medicaid Created in 1965 as Title XIX of the Social Security Act, Medicaid is a 

federal-state health care financing program that covers medical and healthrelated services to certain categories of the country’s low-income 

population, primarily children and individuals who are aged, blind, or 

disabled. Medicaid programs operate in each state, the District of 

Columbia, Puerto Rico, and the other insular areas.
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Federal Social Programs

Page 182 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 35: Estimated Medicaid Enrollment and Federal Expenditures, Fiscal Year 

2004 

Source: GAO analysis of CMS and Puerto Rico data. 

a

The figure represents the number of enrollees in terms of person years. The total number of 

individuals served by Medicaid in 2004 was nearly 55 million, some of whom were enrolled in the 

program for less than the full year. A similar number for total individuals served by Medicaid in Puerto 

Rico was not available.

b

The figure includes expenditures for medical services and administration.

The Medicaid programs in Puerto Rico and the other insular areas has 

financing, eligibility, service, and administrative requirements that differ 

from Medicaid requirements and operations in the states. 

Financing In the states, there are no limits on federal payments for Medicaid as long 

as the state contributes its share of program expenditures for services 

provided under a federally approved plan. A statutory formula is used to 

calculate the portion of each state’s Medicaid expenditures for medical 

assistance that the federal government will pay, referred to as the federal 

matching percentage. The matching percentage varies by state, depending 

in part on the state’s per capita income in relation to the national average, 

and ranges from 50 to no more than 83 percent of Medicaid expenditures.11

For fiscal year 2005, the highest federal matching percentage was 77.

The federal share of expenditures in the insular areas is limited to a 50 

percent matching rate, and in contrast to the states, federal Medicaid 

spending for the insular areas is subject to statutory caps.12 For fiscal year 

1999 and beyond, the spending caps are increased annually by the 

 Total for the states, 

Puerto Rico, and the 

other insular areas Puerto Rico 

Puerto Rico as

percent of total

Enrollmenta 42.9 million 938,000 2.2

Federal expenditures $173.7 billionb $219.4 million 0.1

11The District of Columbia has a higher matching percentage than what would be calculated 

under the statutory formula. This higher matching rate, which is currently 70 percent, was 

authorized by the Balanced Budget Act of 1997, Pub. L. No. 105-33 § 4725(b)(1), 111 Stat. 

251, codified at 42 U.S.C. § 1396d(b)(3). 

12Puerto Rico was originally included in the legislation that created Medicaid and was 

granted a 55 percent federal matching rate. Effective in 1967, its federal matching rate was 

lowered to 50 percent. 
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Page 183 GAO-06-541 Puerto Rican Fiscal and Economic Trends

percentage increase in the medical-care component of the CPI for all urban 

consumers. 

Eligibility In the states, Medicaid requires coverage of certain categories of lowincome individuals, including children, pregnant women, and aged and 

disabled individuals. For example, federal law requires coverage of 

pregnant women and children up to age 6 in families with incomes up to 

133 percent of the FPL, and children age 6 through age 18 in families with 

incomes up to 100 percent of the FPL. However, insular areas are not 

required to meet all Medicaid eligibility requirements, and in light of the 

statutory limits on federal funding, CMS does not hold these areas 

accountable for covering all Medicaid benefit requirements. For example, 

Puerto Rico and the U.S. Virgin Islands have implemented eligibility criteria 

that are more restrictive than federal standards. They determine Medicaid 

eligibility based on locally established poverty levels, which, at less than 

the federal poverty level, are more restrictive in terms of enrollment. 

According to officials in these areas, restricting eligibility allows them to 

target Medicaid services to fewer, albeit needier, individuals. Puerto Rico’s 

locally established poverty level, called the Commonwealth poverty level 

(CPL) is currently $8,220 per year for a family of four and has not changed 

since 1998. In contrast, American Samoa, whose median household income 

is less than half that of the United States, neither uses specific categories to 

determine eligibility nor links eligibility to income levels that reflect local 

conditions. Instead, it considers every resident with an income at or below 

the federal poverty level—the majority of the population—as eligible for 

Medicaid. 

Services and Administration Medicaid also requires states to cover certain services in their Medicaid 

programs.13 Mandatory services include inpatient and outpatient hospital 

care; physician services; nursing home care; lab and x-ray services; 

immunizations and other early and periodic screening, diagnostic, and 

treatment (EPSDT) services for children under age 21; family planning 

services; health center and rural health-clinic services; and nurse midwife 

and nurse-practitioner services. Services that are optional include 

outpatient prescription drugs, institutional care for persons with mental 

retardation, personal care, and dental and vision care for adults. With 

13The Deficit Reduction Act of 2005 allows states to establish “benchmark benefit packages” 

for certain eligible populations that would not include all of the services previously 

classified as mandatory. See Pub. L. No. 109-171 § 6044; 120 Stat. 4, 88-92. This section of the 

law will take effect on March 31, 2006.
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certain exceptions, states’ Medicaid programs must allow recipients 

freedom of choice among health-care providers participating in Medicaid. 

Also, overall administrative expenditures for states are not limited, and 

states receive a 50 percent federal match for most types of administrative 

expenditures.14

Despite federal requirements for mandatory coverage of certain services, 

the Medicaid programs in the insular areas do not cover all mandatory 

services. For example, while Puerto Rico has skilled nursing facilities and 

home health services, its Medicaid program does not include them in its 

benefit package. Similarly, other mandatory Medicaid services, such as 

nurse midwife services, are also not covered by Puerto Rico’s Medicaid 

program.15 However, Puerto Rico and the other insular areas have all 

chosen to add optional benefits under the statute, such as outpatient 

prescription drug coverage. In addition, as is the case with all the insular 

areas, Puerto Rico is exempt from freedom of choice requirements that 

apply to states’ Medicaid programs. Also, federal spending for 

administrative expenditures in Puerto Rico and the other insular areas are 

subject to their respective Medicaid caps. 

State Children’s Health 

Insurance Program

The State Children’s Health Insurance Program (SCHIP) was enacted in 

1997 as Title XXI of the Social Security Act to provide health care coverage 

to low-income, uninsured children living in families whose incomes exceed 

the states’ eligibility limits for Medicaid.16 In general, states and insular 

areas may design their SCHIP programs in one of three ways—by 

expanding their Medicaid programs, developing separate child health 

programs that function independently of Medicaid, or combining these two 

approaches. As of April 2005, 17 states and insular areas opted to expand 

their Medicaid programs, 18 states opted to develop separate programs, 

and 21 states had combination programs. An SCHIP Medicaid expansion 

must follow Medicaid rules, including enrollment structure and benefits. A 

state that chooses a separate program has greater flexibility in designing its 

14Certain administrative expenditures are eligible for higher federal matching rates. For 

example, there is a 75 percent federal match for quality review of hospital services and the 

operation of Medicaid management information systems. 

15According to Puerto Rico government officials, some EPSDT services for children are 

effectively limited by the federal spending cap. 

16Pub. L. No. 105-33 § 4901, 111 Stat. 251, 552-570. 
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SCHIP program and may introduce limited cost-sharing or offer different 

benefit packages. While Puerto Rico expanded its Medicaid program to 

cover additional children, none of the other insular areas has developed a 

unique SCHIP program to extend health insurance coverage to additional 

children as is done in the states.17 Instead, the insular areas, besides Puerto 

Rico, primarily use SCHIP funds to pay for services provided to Medicaideligible children once the Medicaid cap has been reached. 

Table 36: Estimated SCHIP Enrollment and Federal Allotments, Fiscal Year 2004 

Source: GAO analysis of CMS and Puerto Rico data.

a

The SCHIP enrollment figure represents the number of enrollees in terms of person years. The total 

number of individuals served by SCHIP in 2004 was 6.1 million, some of whom were enrolled in the 

program for less than the full year. A similar number for total individuals served by the SCHIP program 

in Puerto Rico was not available.

In contrast to Medicaid, where federal funding to states is open-ended, the 

SCHIP statute provides for an annual allotment for each state, Puerto Rico, 

and the other insular areas for fiscal years 1998 through 2007. The insular 

areas, including Puerto Rico, receive a total of 0.25 percent of the annual 

nationwide SCHIP appropriation,18 which is allotted among them based on 

set percentages.19 The SCHIP statute also provides for an enhanced federal 

17Guam also used SCHIP funds to pay for coverage to children whose coverage was 

previously paid for by the local government. Although none of the insular areas besides 

Puerto Rico have not expanded coverage to include additional children, CMS considers 

insular area SCHIP programs Medicaid expansions.

Total for the states, 

Puerto Rico, and the 

other insular areas Puerto Rico 

Puerto Rico as

percent of total

Enrollmenta 4.1 million 78,785 1.9

Federal allotments $3.175 billion $30.3 million 1.0

18In addition to the 0.25 percent allotment, each of the insular areas receives supplemental 

SCHIP payments through fiscal year 2007. For fiscal years 1998 to 2002, the insular areas 

and Puerto Rico also received redistribution funds, which are SCHIP funds not spent by 

states within the prior 3-year period. The insular areas are eligible for 1.05 percent of the 

total available redistribution funds, which are allocated among them according to the 

percentages each receives of the initial annual allotment. The amounts listed in table 20 

include these supplemental funds.

19SCHIP funds are allotted in the following proportions: Puerto Rico—91.6 percent; Guam—

3.5 percent; the U.S. Virgin Islands—2.6 percent; American Samoa—1.2 percent; and 

CNMI—1.1 percent.
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matching rate that exceeds the rates established by Medicaid. The SCHIP 

enhanced match is equal to each state’s and insular area’s Medicaid 

matching rate plus 30 percent of the difference between the Medicaid 

match and 100 percent, not to exceed a federal share of 85 percent. Thus, 

states that receive the minimum 50 percent Medicaid match, receive a 65 

percent match under SCHIP. Similarly, because the Medicaid match rate for 

all insular areas is set at 50 percent, they also receive a 65 percent match 

rate under SCHIP.

As with the Medicaid program, eligibility for SCHIP in Puerto Rico is tied to 

its CPL. In 1998, Puerto Rico implemented its SCHIP program for children 

under age 19 with family incomes between 100 and 200 percent of the CPL. 

As a Medicaid expansion, Puerto Rico’s SCHIP program covers the same 

benefits and services as provided under its Medicaid program, which are 

similar, but not the same, as those provided in the states. For states and 

insular areas, SCHIP administrative expenses are limited to 10 percent of 

available expenditures. 

Health Grants The states and insular areas also receive health-related grants from a 

number of agencies within the Department of Health and Human Services 

(HHS), including the Centers for Disease Control and Prevention (CDC), 

the Health Resources and Services Administration (HRSA), the National 

Institutes of Health (NIH), and the Substance Abuse and Mental Health 

Services Administration (SAMHSA). These four agencies represent the 

largest sources of health-related HHS grant funds apart from Medicare, 

Medicaid, and SCHIP.20 Grants from these agencies may be used to fund a 

variety of services and activities, including immunization programs, 

bioterrorism preparedness programs, community health centers, programs 

for individuals with HIV or AIDS, maternal and child health grants, 

scientific medical research, and substance abuse prevention and treatment. 

Grants from CDC, HRSA, and SAMHSA tend to fund direct health service 

programs and are often awarded to public health agencies, while NIH 

grants fund scientific medical research and are generally awarded to 

universities.

20Other HHS agencies provide smaller awards that were not considered in this analysis.
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Table 37: Population and Estimated Grant Awards from Four Health and Human 

Service Agencies, Fiscal Year 2004

Source: GAO analysis of HHS Tracking Accountability in Government Grants System data.

a

Population figures are based on the 2000 census and include the states and insular areas.

In general, the process Puerto Rico and the other insular areas must follow 

to apply for federal grants are the same as in the states. However, 

differences exist in how some grant awards are calculated. For example, 

Puerto Rico and the other insular areas are treated differently from the 

states for two of SAMHSA’s grants: The Community Mental Health Block 

Grant and the substance abuse prevention and treatment block grant. 

These grants are allocated among the states based on a set formula with a 

minimum amount for each state. In contrast, Puerto Rico and the other 

insular areas receive 1.5 percent of the total appropriation in block grant 

funds. The funds are divided among each insular area according to its share 

of the total insular area population.21 However, Puerto Rico is treated as a 

state for certain other grants, such as the bioterrorism grants from HRSA 

and CDC. 

Dollars in millions

Total for the 

states, Puerto 

Rico, and the 

other insular 

areas Puerto Rico

Puerto Rico as

percent of 

total

Populationa 285.6 3.8 1.3

Total awards from four HHS 

agencies $33,550.4 $272.5 0.8

Center for Disease Control and 

Prevention (CDC) 4,480.5 47.5 1.1

Health Resources and Services 

Administration (HRSA) 5,857.6 131.8 2.2

National Institutes of Health 

(NIH) 20,336.1 59.7 0.3

Substance Abuse and Mental 

Health Services Administration 

(SAMHSA) 2,876.2 33.5 1.2

21For both of these block grants, each insular area will receive a minimum amount of 

$50,000, even if its share of the 1.5% would be less than $50,000.
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Income Assistance 

Programs

Aid to the Aged, Blind, or 

Disabled

The Social Security Amendments of 197222 created Supplemental Security 

Income (SSI), a cash payment entitlement program that replaced grant 

programs providing economic assistance to low-income adults who are 

aged, blind, or disabled in the states. Eligibility for SSI was extended to 

CNMI, effective 1978. The SSI program does not include Puerto Rico, 

American Samoa, Guam, or the U.S. Virgin Islands. 

Instead, for adults in these groups, these insular areas have continued to 

operate their grant programs that existed before SSI was created. Puerto 

Rico, for example, operates an adult assistance program—Aid to the Aged, 

Blind, or Disabled (AABD). The federal government provides a grant in the 

form of a 75 percent match of state funds for payments for AABD 

recipients—subject to a cap on Puerto Rico’s combined payments for 

Temporary Assistance for Needy Families (TANF—see below), AABD, and 

foster care and related payments—and a 50 percent match for 

administrative expenses. In contrast to SSI, which has federally determined 

cash benefits, Puerto Rico determines its own benefit amounts for AABD. 

In fiscal year 2003, the federal government provided $21 million in benefits 

to 41,567 AABD recipients. Puerto Rico provided a monthly benefit of $64 

for one person. In contrast, the monthly SSI benefit rate for one person not 

living independently was $368 in January 2003. 

Temporary Assistance for 

Needy Families 

The Personal Responsibility and Work Opportunity Reconciliation Act of 

1996 (PRWORA) repealed the Aid to Families with Dependent Children, 

Job Opportunities and Basic Skills Training, and Emergency Assistance 

programs and created TANF.23 The purposes of TANF are to increase state 

flexibility in operating a program to (1) help needy families care for 

children at home; (2) end dependence of needy parents upon government 

benefits by promoting job preparation, work, and marriage; (3) reduce outof-wedlock pregnancies; and (4) encourage formation and maintenance of 

22Pub. L. No. 92-603.

23Pub. L. No. 104-193.
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two-parent families. TANF has a 5-year time limit on federal cash 

assistance for most families and requires states to impose federally 

established work and other program requirements on most adults receiving 

aid. Otherwise, states and insular areas have broad flexibility to design 

their own eligibility rules and the types of services provided. 

The insular areas participating in TANF are subject to the same 

requirements as the states, although these insular areas are not eligible to 

receive all of the five TANF grants. The states and Puerto Rico, Guam, and 

the U.S. Virgin Islands operate TANF programs.24 American Samoa does not 

participate in TANF, and CNMI is not eligible because it was not included in 

PRWORA. Federal funding for Puerto Rico, Guam, the U.S. Virgin Islands, 

and American Samoa is capped for TANF, AABD, foster care and adoption 

assistance, and independent living programs. The federal government 

provides a basic TANF block grant to cover benefits, administrative 

expenses, and services targeted to needy families in the states and insular 

areas. The amount of the grant reflects expenditures in pre-TANF 

programs. To receive this grant, states and insular areas must provide at 

least 75 percent of the amount of state funds they spent on programs 

replaced by TANF in fiscal year 1994. Like the states, Puerto Rico, Guam, 

and the U.S. Virgin Islands can receive additional TANF bonuses for high 

performance and a reduction in out-of-wedlock births. Furthermore, a 

special provision allows the insular areas to receive funding above their 

federal TANF grant if certain conditions are met. Puerto Rico did not 

qualify to receive such funding in fiscal year 2003.25 The insular areas are 

not eligible to receive contingency funds or supplemental grants for 

population increases that states may qualify to receive. Table 38 compares 

selected TANF program data on Puerto Rico to national data for fiscal year 

2003. 

24Puerto Rico implemented its TANF program on July 1, 1997. 

25Under section 1108(b) of the Social Security Act, additional federal matching grant funds 

(up to the capped amount) are available to an insular area if its expenditures exceed the 

capped amount of its TANF block grant and its required state expenditure. The total 

expenditure requirement is $99.7 million.
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Table 38: Comparison of Selected Data on TANF Program in Puerto Rico to TANF Program in the States, Fiscal Year 2003

Sources: U.S. Department of Health & Human Services, Congressional Research Service: TANF Cash Benefits As of January 1, 2004, 

Puerto Rico fiscal year 2003 State Plan. 

a

Includes only the states, not Puerto Rico or the other insular areas. 

b

Includes the states, Guam, the U.S. Virgin Islands, and Puerto Rico.

Programs for the Care 

of Children

Child Care and 

Development Fund 

PRWORA increased the amount of federal funding for child-care subsidies 

for low-income families, with the expectation that the newly implemented 

work requirements for welfare recipients—many of whom are single 

mothers—would create a greater demand for child-care services as 

recipients went to work or participated in training or education. Funding is 

provided through two funding streams: one discretionary and one 

mandatory. These two streams constitute the Child Care and Development 

Fund (CCDF).

All states and all insular areas are eligible to receive CCDF funds. All states 

and insular areas can receive funds under the discretionary portion of 

CCDF, but only the states can receive funds under the mandatory portion of 

the grant. Funding amounts for the discretionary portion of CCDF are 

determined in the annual appropriations process, while funding amounts 

for the mandatory portion are directly appropriated by the welfare reform 

law. CCDF gives states and insular areas greater flexibility to design their 

child-care policies than previous federal child-care policy.

The states, Puerto Rico, and the 

other insular areas Puerto Rico 

Total federal expenditure $16.25 billiona $38.38 million

State expenditures at 75 percent rate $10.35 billiona $21.19 million

Total number of recipients (as of March 2003) 4.96 millionb 54,544

Monthly TANF benefits for a family of three Ranges from $170 to $923, 

depending on state

$160
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Table 39: Child Care and Development Fund Expenditures and Children Served, 

Fiscal Year 2003

Source: U.S. Department of Health & Human Services.

a

Includes mandatory, matching, and discretionary CCDF funds for the states, Puerto Rico, and the 

other insular areas. 

b

Includes only discretionary funds.

c

Average number of children served per month for the states, American Samoa, and Guam.

d

Total number of children served for entire year. 

Foster Care and Adoption 

Assistance Funds

Title IV-E of the Social Security Act authorizes the foster care and adoption 

assistance programs.26 These programs provide federal funds to help offset 

child welfare costs related to providing (1) safe, appropriate substitute care 

for children who need temporary placement outside their homes because 

of abuse and neglect, and (2) subsidies to families or individuals adopting 

children who meet certain eligibility requirements. The states and Puerto 

Rico participate in these programs and receive federal funds for their 

administration. Table 40 shows the total child welfare population and data 

for Puerto Rico for fiscal year 2001.

States, Puerto Rico, and 

the other insular areas Puerto Rico

Expenditures $7.25 billiona $57.15 millionb

Number of children served 1.75 millionc 25,917d

26Pub. L. No. 96-272.
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Table 40: Estimated Child Welfare Population, Fiscal Year 2001

Source: Adoption and Foster Care Analysis and Reporting System, preliminary estimates for fiscal year 2001 (as of March 2003), as 

reported in U.S. Department of Health and Human Services, Administration for Children and Families, Administration on Children, Youth, 

and Families, Children’s Bureau, Child Welfare Outcomes 2001: Annual Report to Congress.

a

Waiting children are children who have a goal of adoption or whose parents’ parental rights have been 

terminated.

For Puerto Rico, foster care and adoption assistance are two of several 

public assistance programs that are subject to a federal funding cap, under 

the 1996 federal welfare law that created the TANF block grant.27 The total 

payment to Puerto Rico for all of these programs—adult assistance, TANF, 

foster care, adoption assistance, and independent living—cannot exceed 

$107,255,000. 

Federal funds are set at the applicable Medicaid matching rate. In fiscal 

year 2003, the matching rate, which ranged from 50 to 83 percent 

nationwide, was 50 percent for Puerto Rico. States and insular areas may 

also claim funds at a rate of 50 percent for administrative costs and at a rate 

of 75 percent for training costs. In 2003, Puerto Rico did not claim either. 

Total for the states and 

Puerto Rico Puerto Rico

Puerto Rico as

percent of total

Children in foster care 542,000 8,476 1.6

Children waiting to be 

adopteda 126,000 418 0.3

Children adopted 50,000 257 0.5

27Pub. L. No. 104-193.
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Table 41: Estimated Federal Foster Care and Adoption Assistance Funding, Fiscal 

Year 2003

Source: Title IV-E State Claims for Expenditures for fiscal year 2003 (as of May 2004) for Adoption and Foster Care. U.S. Department of 

Health and Human Services, Administration for Children and Families, Administration on Children, Youth, and Families, Children’s 

Bureau.

Note: According to HHS, for both foster care and adoption, Puerto Rico’s claims for the 4th quarter of 

fiscal year 2003 were estimated using the average of the previous three quarters.

Housing Programs

Public Housing Program The public housing program was authorized by the United States Housing 

Act of 1937 to provide decent, safe, and affordable housing for low-income 

families through public housing authorities (PHA).28 Through this program, 

eligible families are able to rent units in single-family or multifamily public 

housing properties, such as high-rise apartments. Families are generally 

required to pay 30 percent of their monthly adjusted household income in 

rent.

Administration and Funding Public housing is owned and operated by approximately 3,200 PHAs 

nationwide. Each PHA is responsible for operating and maintaining its 

public housing inventory and managing the selection of residents. 

Public housing can be developed through the construction of units on a site 

owned by a PHA, development of units on a developer-owned site that is 

sold to the PHA after completion, or through units that the PHA purchases. 

The Department of Housing and Urban Development (HUD) has not 

provided new funding for public housing development since fiscal year 

1994. However, PHAs can use capital and HOPE VI funding (see below) for 

development.

Federal share for 

the states and 

Puerto Rico 

Federal share 

for Puerto Rico

Puerto Rico 

as percent of 

total

Adoption Assistance Payments $1.17 billion $373,000 3.2

Foster Care Payments $1.69 billion $14 million 0.008

28Pub. L. No. 75-412.
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HUD provides annual formula-based subsides to PHAs to operate and 

maintain public housing. These subsidies, which consist of operating and 

capital (formerly modernization) funds, supplement rent paid by tenants. 

Public Housing in Puerto Rico 

and Other Insular Areas

Operating subsidies for PHAs in the states, Puerto Rico, the U.S. Virgin 

Islands, and Guam are generally calculated by subtracting estimated rental 

income from the allowable utility and nonutility expense levels.29 However, 

these expenses for Puerto Rico, the U.S. Virgin Islands, Guam, and Alaska 

were initially determined using a slightly different methodology than that 

used in most of the states. A HUD public housing fund regulation changed 

the way operating subsidies are calculated for Puerto Rico, the U.S. Virgin 

Islands, Guam, and Alaska—these PHAs will no longer receive funding for 

operating costs outside of the general operating fund formula. 

The capital fund grant formula is generally applied in the same way to 

PHAs in the states, Puerto Rico, and the other insular areas. Regulations 

governing the administration of public housing also apply to PHAs in the 

states, Puerto Rico, and the other insular areas. Eligibility rules are the 

same for all residents, regardless of where they live. 

The Puerto Rico Public Housing Administration (PRPHA) administered all 

56,524 units of public housing in Puerto Rico in fiscal year 2005. PRPHA 

ranked third among all PHAs in the amount of annual operating fund 

subsidy received in fiscal year 2002 (see table 42), and second in the 

number of public housing units (see table 43). HUD’s Caribbean field office 

is responsible for overseeing PRPHA’s administration of these units. 

29No information was available on public housing in CNMI and American Samoa. 
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Table 42: Estimated Amount and Percent of Total Operating Subsidy Received by 

the Five Largest Public Housing Authorities, Fiscal Year 2002

Source: HUD.

Table 43: Total Number and Percent of Public Housing Units for the Five Largest 

Public Housing Authorities, Fiscal Year 2005

Source: HUD.

In fiscal year 2004, PRPHA received approximately $148 million in capital 

fund grants (approximately 6 percent of that year’s appropriation for the 

capital fund). 

Public housing authority

Operating subsidy 

(millions)

Percent of total operating 

subsidy

New York City Housing 

Authority $752 22

Chicago Housing Authority 182 5

Philadelphia Housing 

Authority 102 3

Puerto Rico Public Housing 

Administration 96 3

Housing Authority of 

Baltimore City 61 2

National $3,495 100

Public housing authority

Number of public housing 

units Percent of total units

New York City Housing 

Authority 161,389 13

Puerto Rico Public Housing 

Administration 56,524 5

Chicago Housing Authority 28,925 2

Philadelphia Housing 

Authority 16,027 1

Housing Authority of 

Baltimore City 14,554 1

National 1,200,000 100
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Housing Choice Voucher 

Program

The Housing Choice Voucher Program is HUD’s largest housing assistance 

program. Authorized by the Housing and Community Development Act of 

1974 as the Rental Certificate Program, it assists extremely low- to lowincome families in obtaining decent, safe, and sanitary rental housing.30

Through this program, eligible families rent privately owned units that they 

would otherwise not be able to afford. Families pay a portion of the rent 

(generally 30 percent of their monthly income, less deductions), and the 

local PHA pays the remainder directly to the property owners. 

Program Administration and 

Funding

Expiring increments of Section 8 housing voucher assistance are 

automatically renewed by HUD. Other vouchers are available either on an 

as-needed, noncompetitive basis or through competitive Notices of 

Funding Availability (NOFA). 

HUD is responsible for developing policies, regulations, and guidance for 

the program, allocating funds, providing technical assistance, and 

monitoring PHAs’ compliance with program requirements. PHAs are 

responsible for determining eligibility, maintaining waiting lists, selecting 

families for admission, inspecting program units for compliance with 

housing quality standards, and making housing assistance payments to 

property owners. Property owners must be willing to participate in the 

program and are responsible for screening and selecting tenants, collecting 

tenants’ share of the rent, and maintaining the property in compliance with 

the program’s housing quality standards. Families with vouchers are 

responsible for choosing the house or apartment that they want to rent. 

Housing Choice Vouchers in 

Puerto Rico and the Other 

Insular Areas

Like Puerto Rico, Guam, CNMI, and the U.S. Virgin Islands are eligible for 

Housing Choice Vouchers. HUD’s Caribbean field office is responsible for 

overseeing PHAs’ administration of Housing Choice Vouchers in Puerto 

Rico. The formula that HUD uses to determine the number of vouchers in a 

given area does not make any exceptions for Puerto Rico or the eligible 

insular areas. The regulations governing the administration of the voucher 

program apply to PHAs in the states, Puerto Rico, and the eligible insular 

areas. Eligibility rules are the same for all residents, regardless of where 

they live. 

30Pub. L. No. 93-383.
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In fiscal year 2003, PHAs in Puerto Rico received approximately $139 

million in funding from HUD to administer the voucher program, which 

was approximately 1.1 percent of total budget outlays for the voucher 

program for the fiscal year. Seventy-seven PHAs administered 

approximately 29,000 vouchers in Puerto Rico, or 1.4 percent of total 

available vouchers. California and New York have the largest number of 

vouchers, CNMI and the U.S. Virgin Islands have the smallest number of 

vouchers, and Puerto Rico ranks 33rd among all the states and insular areas 

that have vouchers (see table 44). 

Table 44: Number of Housing Choice Vouchers and Estimated Budget Authority in 

Puerto Rico and Selected States and Insular Areas, Fiscal Year 2003

Source: HUD.

Community Development 

Block Grant Program

HUD’s Community Development Block Grant Program (CDBG) is the 

largest source of federal assistance for state and local governments’ 

community development and neighborhood revitalization activities. These 

programs include “entitlement grants”—which award grants to qualified 

units of general local government to provide decent housing and a 

sustainable living environment and to expand economic opportunities for 

low- and moderate-income individuals—and state-administered CDBG, 

which awards grants to states which in turn make grants to nonentitlement 

units of general local government to carry out similar developmental 

activities. 

Program Administration and 

Funding

Under the entitlement communities program, HUD determines the amount 

of each grant by a statutory formula that uses several objective measures of 

community needs, including the extent of poverty, population, housing 

overcrowding, age of housing, and population growth lag relative to other 

metropolitan areas. To receive its annual grant, a grantee must develop and 

State

Number of housing

choice vouchers

Estimated budget 

authority

California 294,701 $2.4 billion

New York 201,558 $1.3 billion

Puerto Rico 28,654 $139 million

U.S. Virgin Islands 1,029 $7 million

CNMI 215 $1.8 million

National 2,054,905 $12,827,326,159
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submit to HUD a consolidated plan, certifications, and application for 

funding. The development goals outlined in the plan serve as the criteria 

against which HUD will evaluate a jurisdiction’s performance and future 

eligibility for funding.

The state-administered CDBG program is designed to provide funding to 

nonentitlement areas, which do not receive CDBG funding as part of the 

entitlement grant program. HUD distributes funds to each state based on a 

statutory formula that takes into account population, poverty, incidence of 

overcrowded housing, and age of housing. Participating states award 

grants to eligible localities to carry out community development activities. 

Each state annually develops funding priorities and criteria for selecting 

projects. HUD ensures participating states’ compliance with federal laws, 

regulations, and policies. 

CDBG in Puerto Rico and the 

Other Insular Areas 

For purposes of determining CDBG grants, Puerto Rico is considered a 

state. Thus, the laws and regulations governing the application for, and 

distribution and use of, CDBG funds apply to Puerto Rico and the states. 

HUD’s Caribbean field office is responsible for overseeing the use of CDBG 

funds in Puerto Rico. 

Each fiscal year, the insular areas may apply for $7 million of CDBG 

funding. Grant amounts are based on population. 

Table 45 provides information on the total CDBG funding for fiscal years 

2001 through 2004, and the percentage of those funds that were used by 

eligible cities and states to fund housing initiatives. 
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 199 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 45: Estimated Disbursement of CDBG Funds for Housing, Fiscal Years 2001–

2004

Source: HUD.

In fiscal year 2004, Puerto Rico received approximately $130 million in total 

CDBG funding—3 percent of total funding for the year. Collectively, Guam, 

the U.S. Virgin Islands, American Samoa, and CNMI received about $6.96 

million in fiscal year 2004. Table 45 provides information on how areas in 

Puerto Rico receiving CDBG funds in fiscal year 2004 used some of their 

CDBG funds for housing-related initiatives. 

HOPE VI Program Originally known as the Urban Revitalization Demonstration, the HOPE VI 

Program was developed as a result of recommendations by the National 

Commission on Severely Distressed Public Housing. In its August 10, 1992, 

Dollars in billions

Entitlement 

program 

Nonentitlement/stateadministered program

Total 

disbursements

(both programs)

Total CDBG funding, 

fiscal year 2001 $3.5 $1.2 $4.7 

Percent of total 

funding used for 

housing initiatives, 

fiscal year 2001 29.4 15.1

Total CDBG funding, 

fiscal year 2002 $3.8 $1.3 $5.1

Percent of total 

funding used for 

housing initiatives, 

fiscal year 2002 27.1 15.1

Total CDBG funding, 

fiscal year 2003 $3.4 $1.3 $4.7

Percent of total 

funding used for 

housing initiatives, 

fiscal year 2003 27.5 14.9

Total CDBG funding, 

fiscal year 2004 $3.5 $1.4 $4.9

Percent of total 

funding used for 

housing initiatives, 

fiscal year 2004 27.0 16.4
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 200 GAO-06-541 Puerto Rican Fiscal and Economic Trends

report to Congress, the commission recommended revitalization in three 

general areas: physical improvements, management improvements, and 

social and community services to address resident needs. 

On the basis of this recommendation, in October 1992, Congress 

appropriated $300 million for the Urban Revitalization Demonstration, also 

known as HOPE VI, as part of the Independent Agencies Appropriations 

Act of 1993.31 The program is designed to replace severely distressed public 

housing with mixed-income housing and to provide housing vouchers to 

enable some of the original public housing residents to rent apartments in 

the private market. The program was authorized through annual 

appropriations until fiscal year 1999 when it was separately authorized as 

part of the Quality Housing and Work Responsibility Act of 1998.32 In fiscal 

years 2004, 2005, and 2006 Congress appropriated $150 million, $144 

million, and $100 million, respectively, for the HOPE VI program. 

Program Administration and 

Funding 

Any PHA that has severely distressed public housing units is eligible to 

apply for a HOPE VI revitalization or demolition grant. HOPE VI 

revitalization grants fund capital costs of major rehabilitation, new 

construction, and other physical improvements; demolition of severely 

distressed public housing; acquisition of sites for off-site construction; and 

community and supportive service programs for residents, including those 

relocated as a result of revitalization efforts. HOPE VI demolition grants 

fund the demolition of severely distressed public housing and relocation of 

residents as a result of the demolition. 

HUD's requirements for HOPE VI grants are laid out in each fiscal year's 

grant agreement and NOFA, which announces the availability of funds and 

contains application requirements, threshold requirements, rating factors,33

and information on the application selection process. HUD has used the 

31Pub. L. No. 102-389.

32Pub. L. No. 105-276.

33A threshold requirement is a requirement that an applicant must meet to be eligible for a 

HOPE VI revitalization grant. Threshold requirements may include the following: (1) the 

PHA must have met all performance requirements under any of its existing HOPE VI grants 

to apply for additional grants, (2) the PHA must submit certification by an engineer or 

architect that the project is severely distressed, and (3) the PHA must verify compliance 

with applicable fair housing civil rights laws. A rating factor is a category used to evaluate 

specific aspects of the application, such as funding need. For each factor, HUD can award 

points, which are used to evaluate PHAs’ applications for revitalization grants.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 201 GAO-06-541 Puerto Rican Fiscal and Economic Trends

same procedure each year to screen, review, and rank grant applications: 

when grant applications are received, they are screened to determine 

whether they meet the eligibility and threshold requirements in the NOFA. 

Next, reviewers rate applications on the basis of the rating factors 

described in the NOFA and rank them. Generally, a group of applications 

representing twice the amount of funds available is sent to a final review 

panel. The final review panel assigns a final score and recommends for 

selection the highest rated applications, subject to the amount of available 

funding.

HOPE VI in Puerto Rico and the 

Other Insular Areas

HUD NOFA requirements and guidelines are generally applied to the PHAs 

in the states, Puerto Rico, and the other insular areas in the same way. 

HUD’s Office of Public Housing Investments at HUD headquarters is 

responsible for monitoring the implementation of HOPE VI grants and 

revitalization plans. 

HOPE VI Grants Between fiscal years 1993 and 2003, PRPHA received one HOPE VI 

revitalization grant, of $50 million. In that same decade, HUD made a total 

of 217 revitalization grants worth approximately $5.5 billion to 118 PHAs in 

34 states, the District of Columbia, and Puerto Rico.34

Between fiscal years 1996 and 2003, Puerto Rico did not receive a HOPE VI 

demolition grant. During the same period, the U.S. Virgin Islands received 

four such grants, totaling approximately $5 million. In that same period, 

HUD made 287 demolition grants worth $395 million to 125 PHAs in 34 

states, the District of Columbia, and the U.S. Virgin Islands. 

HOME Investment 

Partnerships Program 

The HOME Investment Partnerships Program is a federal formula block 

grant to state and local governments designed to create affordable housing 

for low-income households. The program provides funds to states and 

localities to build, buy, and rehabilitate affordable housing for rent or 

homeownership. Also, funds can be given to low-income people to help pay 

their rent. At least 90 percent of HOME funds used for rental housing and 

rental assistance must be used for families whose income is below 60 

percent of the median income in their area; in rental projects with five or 

more assisted units, at least 20 percent of the units must be occupied by 

families with incomes that do not exceed 50 percent of the median income. 

34No information was available on HOPE VI funding in American Samoa, Guam, and CNMI.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 202 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Homeownership assistance must benefit families below 80 percent of the 

median income in their area. 

Program Administration and 

Funding

Program funds are allocated to state and local governments based on a 

formula that considers the relative inadequacy of each jurisdiction’s 

housing supply, incidence of poverty, fiscal distress, and other factors. 

Shortly after HOME funds become available each year, HUD informs 

eligible jurisdictions of the amounts allocated for them. HUD establishes 

trust funds for each grantee, providing a line of credit that the jurisdiction 

may draw upon as needed.

The participating jurisdiction is responsible for managing the day-to-day 

operations of its HOME program, ensuring that funds are used according to 

program requirements and written agreements and taking appropriate 

actions when performance problems arise. 

HOME in Puerto Rico and the 

Other Insular Areas 

For purposes of determining grants under the program, Puerto Rico is 

considered a state.35 Thus, the laws and regulations governing the 

application for, and distribution and use of, HOME funds apply to Puerto 

Rico as they do to the states. HUD’s Caribbean field office is responsible for 

overseeing the use of HOME funds in Puerto Rico. HUD regulations cap the 

amount of funding Puerto Rico and its localities can receive under HOME. 

The initial HOME allocation amount for each of the insular areas is based 

on its population and occupied rental units compared to all the insular 

areas. HUD may reduce an insular area’s allocation based on its 

performance in using HOME funds. The Honolulu field office is responsible 

for overseeing the use of HOME funds in Guam, American Samoa, and 

CNMI. HUD’s Caribbean office is responsible of overseeing the use of 

HOME funds in the U.S. Virgin Islands. 

For fiscal year 2005, Puerto Rico and the other insular areas received 

HOME grants totaling $37,349,848, approximately 2 percent of total HOME 

funding for the year (see table 46). 

35For purposes of the American Dream Downpayment Initiative—a subprogram under 

HOME that provides downpayment and closing cost assistance to low-income families.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 203 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Table 46: Estimated Amount of HOME Grants for Puerto Rico and the Other Insular 

Areas, Fiscal Year 2005

Source: HUD.

Project-based Section 8 

Program

The Housing and Community Development Act of 197436 amended the U.S. 

Housing Act of 1937 to create project-based Section 8, under which a 

variety of programs provide rental housing assistance payments to private 

landlords on behalf of eligible families.37 The objective of the program is to 

provide decent, safe, and sanitary housing to families that have extremely 

low-to low-incomes. 

Project-based Section 8 subsidies are linked to specific multifamily 

properties, wherein all the units may be subsidized by the program. The 

subsidy can be used in properties with subsidized mortgages or mortgage 

insurance under various multifamily housing programs or in properties that 

have been privately financed.38

Through rent subsidies, payments to private landlords cover the difference 

between what the family is required to pay (generally 30 percent of 

adjusted income) and the actual rent for the property. Because the subsidy 

is linked to the unit, tenants lose the subsidy if they move.

Total grant amount

Puerto Rico: state $17.8 million

Puerto Rico: local (27 localities) 15.9 million 

Total for Puerto Rico $33.7 million

Guam 1.4 million

U.S. Virgin Islands 1.2 million

CNMI 642,000

American Samoa 338,000

Total for Insular Areas $37.3 million

36Pub. L. No. 93-383.

37Project-based Section 8 refers to the following programs: New Construction/Substantial 

Rehabilitation, Loan Management Set-Aside, Property Disposition, Moderate Rehabilitation, 

and Preservation. 

38Examples include programs under HUD’s sections 221(d)(3) or 221(d)(4), Section 202, and 

Section 236 programs, and the Department of Agriculture’s Section 515 program.
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 204 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Program Administration and 

Funding

HUD has primary responsibility for contract administration but has 

assigned portions of these responsibilities to project-based contract 

administrators, generally state housing finance agencies or PHAs. Private 

owners enter into individual housing assistance payment contracts for each 

of their properties receiving assistance.

Congress appropriates the amount of project-based Section 8 funding 

available to HUD each fiscal year. Funding for project-based Section 8 is 

currently available only as contract renewals for properties with existing 

contracts. While no new funding is available, families that are not receiving 

assistance may apply for subsidies on properties with existing projectbased rental assistance contracts. 

Project-based Section 8 in Puerto 

Rico

In 2000, HUD began transferring the administration of eligible projectbased Section 8 contracts in Puerto Rico from HUD field offices to the 

Puerto Rico Housing Finance Corporation, a contract administrator. HUD’s 

Atlanta field office is responsible for overseeing the corporation’s oversight 

of project-based Section 8 contracts in Puerto Rico. 

Regulations governing the administration of the program apply to property 

owners and contract administrators in the particular state or insular area 

(the Guam administrator also oversees CNMI). Eligibility rules are the 

same for residents in all areas. As of 2004, Puerto Rico, Guam, and the U.S. 

Virgin Islands all had project-based Section 8 properties.

In fiscal year 2005, the Puerto Rico Housing Finance Cooperation 

administered about 180 project-based Section 8 contracts covering more 

than 19,000 units. 

Section 203(b) Single 

Family Mortgage Insurance 

Program

The Federal Housing Administration (FHA) Section 203(b) mortgage 

insurance program promotes homeownership for families with low to 

moderate incomes by providing mortgage insurance for the purchase or 

refinancing of a principal residence. The program provides mortgage 

insurance to protect lenders, such as mortgage companies, banks, and 

savings and loan associations, against the risk of default on loans to
Appendix VII

Additional Details on the Application of 

Federal Social Programs

Page 205 GAO-06-541 Puerto Rican Fiscal and Economic Trends

qualified buyers. The insurance allows homebuyers to finance 

approximately 97 percent of the home’s cost through their mortgage.39

The Section 203(b) Single-Family 

Mortgage Insurance Program in 

Puerto Rico and the Other 

Insular Areas

Individuals in the states, Puerto Rico, Guam, and the U.S. Virgin Islands are 

eligible for the program. HUD insures 203(b) mortgages and oversees the 

selling of homes where families with Section 203(b) insurance cannot meet 

their payments.40

Section 214 of the National Housing Act41 provides that Section 203(b) 

mortgage limits for Alaska, Guam, Hawaii, and the U.S. Virgin Islands may 

be adjusted up to 150 percent of the mortgage ceilings set for those areas. 

This provision, however, does not apply to Puerto Rico or the other insular 

areas. 

For fiscal year 2006, HUD commitments to guarantee single-family loans 

cannot exceed a loan principal of $185 billion for the Section 203(b) 

program. In fiscal year 2004, 8,269 residents of Puerto Rico received a 

Section 203(b) loan. As of April 2005, halfway through fiscal year 2005, 

4,162 residents had received such a loan.

39Another HUD program, the Section 203(k) program, enables homebuyers and homeowners 

to finance the purchase (or refinancing) and rehabilitation of a house that is at least a year 

old through a single mortgage. 

40When this occurs, the lender forecloses on the home: HUD pays the lender what is owed, 

takes ownership of the home, and attempts to sell the home at its market value.

4112 U.S.C. 1715d.
Page 206 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix VIII

U.S. Gross Domestic Product Deflator and 

Puerto Rican Gross Product Deflator, 

1980–2005 ApendxiVI

Source: Bureau of Economic Analysis and the Puerto Rico Planning Board.

Note: The U.S. series has been adjusted to reflect the Puerto Rican fiscal year.

U.S. GDP

Deflator

Puerto Rico

Gross Product Deflator

(2005=100) (2005=100)

1980 46.788 36.358

1981 51.306 39.729

1982 55.262 42.402

1983 57.990 44.746

1984 60.138 46.853

1985 62.234 48.117

1986 63.762 49.631

1987 65.322 51.001

1988 67.264 52.805

1989 69.863 54.648

1990 72.405 57.743

1991 75.228 60.403

1992 77.357 62.260

1993 79.083 63.919

1994 80.811 66.078

1995 82.560 68.225

1996 84.175 70.490

1997 85.680 72.623

1998 86.824 76.363

1999 87.915 80.011

2000 89.492 84.080

2001 91.562 88.083

2002 93.534 90.440

2003 95.248 93.284

2004 97.393 96.326

2005 100 100
Page 207 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix IX

Agency Comments ApendxiIX
Appendix IX

Agency Comments

Page 208 GAO-06-541 Puerto Rican Fiscal and Economic Trends
Appendix IX

Agency Comments

Page 209 GAO-06-541 Puerto Rican Fiscal and Economic Trends
Page 210 GAO-06-541 Puerto Rican Fiscal and Economic Trends

Appendix X

GAO Contact and Staff Acknowledgments ApendxiX

GAO Contact James R. White, (202) 512-9110, whitej@gao.gov

Acknowledgments

Strategic Issues Jim Wozny, Assistant Director

Tara Carter, Senior Analyst-in-Charge

Jennifer Gravelle, Senior Analyst

Latesha Love, Senior Analyst

Elwood White, Senior Analyst

Tina Younger, Senior Analyst

Laura Nielsen, Analyst

Applied Research and 

Methods

Mitch Karpman, Assistant Director

Ed Nannenhorn, Senior Economist

Jim Ungvarsky, Senior Analyst

Susan Baker, Data Analyst

General Counsel Cheryl Peterson, Senior Attorney

Health Care Gerardine Brennan, Senior Analyst

Margaret Weber, Senior Analyst

Education, Workforce, and 

Income Security

Carolyn Taylor, Assistant Director

Carolyn Blocker, Senior Analyst

Nagla’a El-Hodiri, Senior Analyst

Joy Gambino, Senior Analyst

Anne Welch, Senior Analyst

Financial Markets and 

Community Investment

Cory Roman, Senior Analyst

(450287)
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